Earnings Call Transcript - REXR Q3 2024

Operator, Operator

Ladies and gentlemen, thank you for standing by. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Rexford Industrial Realty Incorporated Third Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. And I would now like to turn the conference over to David Lanzer, General Counsel. You may begin.

David Lanzer, General Counsel

We thank you for joining Rexford Industrial's third quarter 2024 earnings conference call. In addition to the press release distributed yesterday after market close, we posted a supplemental package and an 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 an 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.

Michael Frankel, Co-CEO

Thank you, David, and thank you everyone for joining Rexford Industrial's third quarter earnings call. I'll begin with a few remarks, followed by Howard and Laura. To begin with, we'd like to thank our Rexford team for your outstanding work delivering another strong quarter. Our team generated a 5.4% increase in FFO per share compared to the prior year quarter, which brings our FFO per share growth to 9.3% for the first nine months of the year compared to the prior year period. With our consolidated stabilized portfolio occupancy of 97.6% at quarter end, our infill Southern California tenant base continues to demonstrate resiliency, driven by the mission-critical nature of our infill locations fueled by regional consumption that remains stable and has continued to grow each year since 2021, driven by the nation's largest regional population and most diverse economy. With regard to general market conditions, increased levels of global unrest, uncertainty related to the presidential election, and an uncertain economic outlook continue to weigh on markets and business decision-making. Although our infill Southern California industrial market continues to demonstrate superior long-term tenant demand fundamentals, current leasing activity reflects some tenants taking longer to make decisions. Looking forward, as the economic and political environment stabilize, we believe our infill Southern California industrial market's favorable supply-demand backdrop inherently positions our market for future rent growth. Most importantly, our Rexford portfolio remains well positioned for favorable FFO per share and net asset value growth, driven by the high quality of our properties and the substantial volume of value-add property repositioning and functional enhancements driving the accretive internal growth embedded within our in-place portfolio. By way of indication, assuming zero market rent growth, we currently project about 34% cash NOI growth embedded within our portfolio, realizable over the next three years. And with this, I'm very pleased to turn the call over to Howard.

Howard Schwimmer, Co-CEO

Thank you, Michael, and thank you all for joining us today. Rexford ended the third quarter with solid operating results, a testament to our value creation business model. The Rexford portfolio continues to be favorably positioned relative to the overall infill market. We executed 1.6 million square feet of leases, driving 394,000 square feet of positive net absorption, equal to positive 80 basis points, outperforming the overall market's negative 25 basis points of net absorption according to CBRE. Leasing spreads in the quarter showed continued strength at 39% and 27% on a net effective and cash basis respectively, in line with our prior quarter projections. Additionally, annual embedded rent steps in our executed leases averaged 3.9%, excluding the lease-up of the 275,000-square-foot Dupont repositioning project, rent steps averaged 4% in-line with prior quarters year-to-date. With regard to market rents, we have seen taking rents for highly functional product comparable to the Rexford portfolio down approximately 2.5% sequentially and 7.5% year-over-year, reflecting continued normalization following the extreme market rent growth during the pandemic of over 80% in aggregate within our infill markets. Turning to Rexford's investment activity. During the quarter, we completed $60 million of investments and subsequent to quarter-end, we closed an additional $70 million investment through an off-market transaction. In aggregate, these investments comprising 550,000 square feet are generating an initial yield of 5.8% and a projected unlevered stabilized yield of 5.9% on total cost. Looking forward, we currently have approximately $200 million of investments under contract or accepted offer, which are subject to customary closing conditions. Moving to our capital recycling program. During the quarter, we disposed of one property, bringing year-to-date disposition activity to $44 million, generating a 12.8% weighted average unlevered IRR. In addition, we are negotiating on over $90 million of dispositions, which will be subject to customary closing conditions. During the third quarter, we rent commenced and stabilized three repositioning and redevelopment projects totaling approximately 325,000 square feet, representing a total investment of $99 million. These projects achieved a weighted average unlevered stabilized yield on total investment of 7.6%. Year-to-date, we have stabilized seven projects across 450,000 square feet, which achieved an 8.4% weighted average unlevered stabilized yield on total investment of $165 million. In the quarter, we also leased our 275,000-square-foot Dupont property in the Inland Empire West, which stabilized subsequent to quarter-end at a 5.5% yield. Importantly, I'd like to thank our Rexford team for your entrepreneurial efforts that continue to drive Rexford's success. And with that, I'm pleased to turn the call over to Laura.

Laura Clark, CFO

Thank you, Howard. Third quarter results were in line with expectations. FFO per share was $0.59, representing 5.4% growth over the prior year quarter. Same property NOI growth on a net effective and cash basis was also in line with projections at 2.6% and 5.3% respectively, bringing year-to-date same property NOI growth to 4.7% on a net effective basis and 7.7% on a cash basis. Third quarter net effective same property NOI growth was driven by a positive 750 basis point contribution from base rent growth, primarily offset by a few items, including 320 basis points related primarily to lower straight-line rent associated with an elevated level of early renewals last year, an 80 basis point impact from the timing of recoveries associated with higher seasonal utility expenses and property taxes and a 70 basis point impact related to bad debt. While bad debt in the quarter was a healthy 30 basis points of revenue, the third quarter of 2023 included the positive reversal of a prior reserve impacting the current order comp. In regard to the balance sheet, net debt to EBITDA is 4.7 times, near our long-term target leverage range of 4 times to 4.5 times. During the quarter and subsequent to quarter-end, we settled $220 million of outstanding forward equity related to our March equity offering and currently have $614 million of net forward proceeds remaining for settlement. In total, we have liquidity of approximately $1.7 billion, including $62 million in cash-on-hand and $995 million available under our revolving credit facility. We have no near-term debt maturities until mid-2026 assuming extension options. Turning to guidance, 2024 FFO per share guidance has been increased by $0.01 at the high and low end of the range to $2.33 to $2.35, representing 7% year-over-year earnings growth per share at the midpoint. Note that our guidance does not include future acquisitions, dispositions or related funding that has not yet closed. 2024 same property NOI growth guidance is now 4.25% to 4.75% and 7% to 7.5% on a net effective and cash basis respectively, both within the range of our previous expectations, reduced 25 basis points at the midpoint. Drivers of our same property NOI growth range include the following expectations. First, 2024 average occupancy of 96.5% to 96.75% compared to our prior range of 96.5% to 97%. We expect fourth quarter occupancy to be impacted by a few known move-outs included in our prior guidance, combined with the timing of lease commencement on vacant units that are now projected to commence in early 2025. Second, full year leasing spreads in line with the prior quarter's forecast at 55% on a net effective basis and 40% on a cash basis. Third, concessions for the full year of approximately 1.75 months, up from one and a half months, largely driven by three leases with longer duration signed in the third quarter. Finally, bad debt as a percentage of revenue in the 50 basis point area in-line with year-to-date and historical averages. Our updated same property NOI growth guidance also includes the projected move out of LL Flooring, occupying 504,000 square feet at our Mission Boulevard property who sold their business after recently filing for bankruptcy. We anticipate the tenant will vacate the building at the end of November. However, per our original redevelopment plan, we are currently in the entitlement process. While the vacate of this large space has an outsized impact on portfolio occupancy, the impact to NOI is relatively nominal due to the current estimated rental rate being approximately 250% below market. Other components of our increased FFO per share guidance range include a positive $0.01 per share contribution from $131 million of acquisition activity, plus an incremental $0.01 per share contribution related to higher than expected occupancy in our non-same property pool, which represents approximately 27% of our total portfolio. The incremental NOI contribution from repositionings and re-developments is in line with our prior projections and full year G&A of $83 million is also unchanged. Looking forward over the next three years, we have an estimated $222 million of internal cash NOI growth embedded within the current portfolio, assuming no further acquisitions in today's market rents and includes $91 million of incremental NOI from repositionings and re-developments, $72 million from the portfolio cash mark-to-market of 19% as we roll in-place rents to current market rates, $51 million from portfolio annual embedded rent steps averaging 3.7% and $8 million from acquisitions closed in the quarter and subsequent to quarter-end. Together, this represents 34% growth in cash NOI over the next three years. Note, that in the third quarter, we captured approximately 350 basis points of mark-to-market, realizing $13 million of incremental annualized NOI. Finally, I would like to quickly touch on the three-year FFO per share outlook we spoke about at the beginning of the year. Based on the dynamic market environment and current conditions as well as the inherent challenges with forecasting the timing of market inflections, we will be focusing on our annual guidance going forward, which we will provide when we report fourth quarter earnings in early February. Before I turn the call over for your questions, I want to recognize and thank our Rexford team. We are inspired daily by your passion and pursuit of excellence. Thank you for all you do to drive the success of Rexford.

Operator, Operator

And your first question comes from John Kim with BMO Capital Markets. Your line is open.

John Kim, Analyst

Thank you, and good morning. I wanted to ask about the slow decision-making that a lot of your tenants are experiencing today. It seems like it's a common theme. What would you attribute this to in terms of whether tenants are pushing back on the higher rent levels versus uncertainty in the economy and the upcoming election? Or is it something else like the cost of holding inventory or automation or another reasonable factor?

Michael Frankel, Co-CEO

Hi, John, it's Michael. Thank you so much for joining us today. I think it's predominantly driven by factors that are not necessarily specific to the company, the tenant or their industry, or sector; really more driven by some of the macro concerns and general decision-making around the economy. We're seeing short-term impacts by elevated levels of economic uncertainty, driven in part by geopolitical unrest globally, uncertainty around the election, and interest rates still remain uncertain as well. A lot of folks had hoped there would be more certainty around interest rates at this point in time. We're seeing tenants delaying their decision-making, perhaps staying put, but it's important to note the underlying strength in the businesses of our typical tenants. Regional consumption remains stable, strong, and growing in Southern California. Our third quarter leasing activity reflects performance that is essentially in line with the guidance set at the beginning of the year. So again, we're not really seeing major surprises in tenant decision-making. I think it's predominantly driven by macro factors. As those factors stabilize, we continue to see a favorable backdrop regarding demand.

John Kim, Analyst

Okay. And then on your rents that you signed this quarter, it was at $17.88 on a GAAP basis. It seems to have bounced around up and down this year. How indicative are the current rents or the rents you signed in the third quarter versus what you will be signing for the remainder of the year and into 2025? It would suggest market rents are declining more than the 7.5% you presented. We're also trying to figure out what the true mark-to-market is on the 2025 expirations.

Michael Frankel, Co-CEO

The difference in rents is primarily due to the mix of leases. I'll pass it to Laura for more detail on that and the rest of your question.

Laura Clark, CFO

Hey, John, thanks for your question. In terms of what Michael said, it's true. It is about the mix of leasing. When we look at our full-year guidance for net effective spreads, as an example, of 55% on a net effective basis and 40% on a cash basis is unchanged from our expectations last quarter. That implies 40% net effective spreads and 25% cash spreads into the third and fourth quarter. Our third quarter spreads came in right in line with our expectations at 39% and 27%. As we look into the fourth quarter, we expect to generate similar spreads to this quarter. What's driving that is the smaller spaces, as our mark-to-market is more near term. The average size is 9,000 square feet and the average term was 3.5 years.

John Kim, Analyst

And Laura, do you have the expiring rent on 2025 expirations? It's presumably lower than $15.10 in your supplement.

Laura Clark, CFO

Yeah, we can follow up with you after the call.

Operator, Operator

And your next question comes from the line of Jeff Spector with Bank of America. Your line is open.

Jeff Spector, Analyst

Great. Thank you. One follow-up from John's first question about the reason why tenants are making slower decisions. There's a key difference, Michael, from what you said compared to what we heard at our conference from some of your peers in our broker call, where the main reason is a result of excess space. Tenants took too much space. I don't think you mentioned that. So, are you making a clear distinction here or is that just another reason you accidentally left off?

Michael Frankel, Co-CEO

Hi, Jeff, thanks so much for joining us. I think we do see that as a driver, but it's probably less of a factor than for the big box product. And that's probably why you don't hear us emphasizing it as much. We continue to see very high utility of our properties by our tenants, and we continue to hear of interest for more space. We're just seeing a delay in decision-making. So I do think the dynamics are a bit different for our smaller tenant base within our infill markets compared to the big-box market, which is why we don't emphasize it the same way.

Jeff Spector, Analyst

Thank you. And then Michael, you also said the mark-to-market is 34%. That would assume market rent stays flat from here. I think you're not providing a market rent forecast now, but can you provide a little bit more color on that comment, the 34%? Are you saying you feel that at least market rents are stabilizing?

Michael Frankel, Co-CEO

I think the 34% is a reference to our embedded NOI growth. Can you clarify the question a little bit?

Jeff Spector, Analyst

I thought at the beginning you said the mark-to-market is 34%. It's on one of your slides and I'd assume that's based on today's market rent. I didn't know if you were implying you think market rents are finally stabilizing for your product.

Laura Clark, CFO

Hey, Jeff, this is Laura. The 34% you're referencing is the embedded NOI growth within our portfolio over the next three years. We have about $222 million of embedded NOI growth from repositionings and redevelopments and mark-to-market, our embedded rent steps as well as acquisitions we closed in the quarter.

Jeff Spector, Analyst

Okay, thank you. Appreciate that. Lastly, I just wanted to confirm on the current redevelopments and lease-up redevelopments; I see some of that is coming online in the coming quarters. Any expectations on the leases signed? Any comments you could make?

Howard Schwimmer, Co-CEO

Hi, Jeff, it's Howard. While we've already commented on the timeline for decision-making being a little slower than we have seen in the past, we are seeing reasonable amounts of activity on space. We've made adjustments to the lease-up timeframes in the redevelopment and repositionings. Some timelines were pushed out by about two months, half of it related to construction delays and half of it really being related to leasing. But overall, there is activity out there, and I echo a lot of the comments Michael made regarding the reasons why decisions are slower. We are fairly optimistic about turning some of that activity into signed transactions in the latter part of the year and into early 2025.

Jeff Spector, Analyst

Great. Thank you.

Operator, Operator

And your next question comes from the line of Craig Mailman with Citi. Your line is open.

Craig Mailman, Analyst

Hey, good morning. Just want to circle back to the redevelopment pipeline here. I know you guys are saying that you've been stabilizing projects in the high 7% range, but then Dupont was sort of 5.5% stabilized. How should we think about where yields or returns are coming on the redevelopments that you guys have underway or going to start soon relative to that 7%, 8%? I mean, was the 5.5% a one-off or is that more of where returns are going to trend, given higher construction costs, moderating rents, and maybe elongated lease-up timeframes?

Howard Schwimmer, Co-CEO

Hi, Craig, it's Howard. You can certainly refer to the supplemental that has all the data property by property in terms of projected yields. But in terms of that specific property, as you recall from some of our prior comments, the 275,000 square feet in the Inland Empire West had been one of the softest segments of that market due to the oversupply of the product. So rents, when you look around all the markets, declined the most for that kind of product due to the amount of vacancy. That's really more of a one-off in terms of the stabilized yield you see there on that particular asset.

Craig Mailman, Analyst

Right. Yeah. I see the 6% unlevered yield in the deck. I just was asked this question because I know the three-year roll forward that you guys pulled this quarter was predicated primarily on the redevelopment. I think it was 11% to 13% that you had talked about. I was trying to get at the reason for pulling that. If you guys are continuing to start redevelopments and it feels like you feel pretty good about your return expectations, could you talk a little bit more about the decision to pull that guidance here so quickly after you gave it?

Laura Clark, CFO

Yeah, Craig, I think it's purely a function of timing because we are really excited about the embedded growth within the portfolio and we're very well positioned to generate substantial growth over the near and long term. When we're looking at the forecast, if you look back to the initial outlook we set at the beginning of the year, it was based on the market dynamics at that time. Since then, there has been continued economic uncertainty, so we believe it's prudent to push aside the forecast at this time. We're really focused on our 2025 growth. We will provide those expectations when we report fourth-quarter earnings.

Craig Mailman, Analyst

Okay, that's fair. Just a clarification on LL Flooring. I know that it didn't last as long as you had hoped to get you through the planning or entitlement stage of that redevelopment. Do you anticipate doing a short-term lease there, or should we just assume that that's going to be down until you guys start the renewal at 1601?

Laura Clark, CFO

Yeah, Craig, I mean, we'll certainly put it on the market and see if we're able to get some short-term income in that space. It's not anticipated at this point in our guidance.

Craig Mailman, Analyst

Okay. And then just maybe one last one. You guys are still sitting on a good amount of cash to deploy. What we're hearing is stabilized yields are coming down on acquisitions, particularly in good gateway markets. How do you guys feel about the return opportunities relative to the cost of capital you raised equity at earlier this year?

Michael Frankel, Co-CEO

Hey, Craig. Thanks again. It's Michael here. We're excited about any opportunities that we might have in our pipeline. The only reason they're in our pipeline is that we believe they're going to deliver substantial accretion. We aim to create value that is accretive both in the near and long-term. It doesn't mean we might not buy a vacant asset from time to time, but we will expect that we'll get paid for that with a substantially higher stabilized yield. In general, we'll continue to prioritize cash-flowing assets with opportunities to create value, focusing on the best opportunities for shareholders.

Operator, Operator

And your next question comes from the line of Nicholas Yulico with Scotiabank. Your line is open.

Nicholas Yulico, Analyst

Thanks. Hi, everyone. I just wanted to go back to the same-store occupancy change in guidance. In terms of the tenant move-out that you talked about, can you quantify how big of an impact that was on the same-store occupancy guidance?

Laura Clark, CFO

In terms of our same-store occupancy guidance, we did reduce the midpoint by about 25 basis points. We reduced the high end by about 25 basis points. The drivers include rent commencement timing, which we pushed out projected commencement into early '25, which accounts for about half of the drivers. Given the overall leasing dynamics, tenants are delaying decisions, and negotiations are taking a little more time. On the largest units that account for the majority of the change, we have activity on about six of those units. It's more about expecting that commencement to be in 1Q and not 4Q. The move-out of LL Flooring is about 10 basis points.

Nicholas Yulico, Analyst

Okay. Yeah, thanks, Laura. So, it sounds like the piece that's being delayed to 2025; there's not anything specifically leased for that space. And there's a lease in place, just not expected to commence until next year. It's all speculative leasing that's being delayed into occupancy for next year.

Laura Clark, CFO

Yes, it's just based on our expectations in terms of commencements and activity we have in the trading paper today.

Operator, Operator

And your next question comes from the line of Nick Thillman with Baird. Your line is open.

Nick Thillman, Analyst

Hey, good morning. Laura, I wanted to touch on some leasing mix dynamics you laid out on the smaller tenants having shorter lease terms. You've converted that mark-to-market on that term. But looking at your schedule, should we view that as since 2026, more larger leases with greater spreads or how should we think about that dynamic?

Laura Clark, CFO

I'm not going to speak to spreads for next year or 2026 at this time, but I look forward to providing more guidance when we report fourth-quarter earnings. It's important to note that we have provided the portfolio net effective mark-to-market at 31% and our cash mark-to-market today is a strong 19% as well.

Nick Thillman, Analyst

Pivoting back to the repositioning and redevelopment bucket, how much of that NOI flow-through are we expecting? Is it logical to see some of that upside in '25 or are we thinking this is still going to continue to be pushed to more '26, '27?

Michael Frankel, Co-CEO

Are you asking specifically about the product that we've delivered or the entirety of the pipeline?

Nick Thillman, Analyst

I'm asking about what you've laid out for the 2027 roll forward, like what percentage of that is logical to see in '25.

Laura Clark, CFO

We provide our stabilization timing for every property within the pipeline, so we'll see some impacts in '25, '26, and '27.

Nick Thillman, Analyst

You're confident about those stabilization dates or have any market dynamics shifted in the last 90 days to sway you one way or the other?

Laura Clark, CFO

Yes. We made updates to some timing, and that's what we're seeing in the market today, which is reflected in our projections around stabilization dates.

Nick Thillman, Analyst

That's it from me. Thanks.

Operator, Operator

And your next question comes from the line of Mike Mueller with JPMorgan. Your line is open.

Mike Mueller, Analyst

What are the attributes of the $90 million of dispositions you're finalizing? To the extent that you find acquisitions, how are you thinking today about incremental dispositions versus pulling down the forward that you have in place?

Howard Schwimmer, Co-CEO

Hi, Mike, it's Howard. We're not yet at a point where we're comfortable reporting specifics until these transactions are closed. However, this is a larger amount of product that we are looking at, and we're excited about the $44 million year-to-date dispositions and the other $90 million that we're working on. But I think we'd be more comfortable giving you more information as we close these transactions.

Laura Clark, CFO

In terms of how we're thinking about funding, we have a pipeline of uses. We have a pipeline of acquisitions of about $200 million. We also have about $75 million of additional repositioning and redevelopment to spend through the remainder of this year and about $200 million next year.

Mike Mueller, Analyst

Got it. Okay. And maybe last quick one; during the quarter, you had sequential occupancy declines of about 200 basis points, San Diego and Ventura. Any color there in terms of some of the moving parts?

Laura Clark, CFO

The sequential decline was primarily due to some properties in San Diego, averaging about 15,000 square feet. There were two larger property move-outs, roughly about 30,000 to 40,000 square feet. One of those in San Diego is already released at a 50% cash spread, and the other is expected to lease at about a 50% cash spread. In Ventura, it was about seven properties averaging 26,000 square feet, driven by two large move-outs, still around 40,000 square feet. Expect to release those at about a 30% cash spread.

Mike Mueller, Analyst

Got it. Thank you.

Laura Clark, CFO

Yeah.

Operator, Operator

And your next question comes from the line of Blaine Heck with Wells Fargo. Your line is open.

Blaine Heck, Analyst

Can you talk about AB 98 and the impact on your portfolio? Are there any planned redevelopments or repositioning projects that may not be possible to build out, given the increased restrictions? Do you expect this to result in better long-term rent growth, or could it push tenants into other markets? How are you thinking about the net effect of all of the aspects of that bill?

Howard Schwimmer, Co-CEO

Hi, Blaine, it's Howard. For the benefit of others listening, AB 98 involves state-level zoning changes, primarily dealing with setback requirements near sensitive uses such as homes, schools, and parks, addressing this with buffer zones. It's mostly impactful to logistics projects that are 250,000 square feet or larger, with nominal impact to products below that. For Rexford, there is no material risk to projects currently in our pipeline. It does not affect repositioning or renovating buildings unless you're adding more than 20% to the size of the building, which is rare in terms of our repositioning. These impacts are mostly seen through larger big-box markets out East.

Blaine Heck, Analyst

Just following up on same-store and the decrease driven mostly by occupancy headwinds. Looking at the timing of occupancy commencements on vacant space, how does that influence same-store NOI as we look forward?

Laura Clark, CFO

That's a great question and we will provide same-property NOI growth guidance when we report fourth-quarter earnings.

Blaine Heck, Analyst

Fair enough. Is the LL Flooring asset going to remain in the same-store pool?

Laura Clark, CFO

This would be a property we executed a short-term lease with LL Flooring at a rate that was 250% below market. We're in the process of redevelopment and currently in entitlements. Because of the low rent, it will impact occupancy, but not necessarily NOI due to the below-market rent. Given this, it will most likely be moved out of the same-property pool next year.

Blaine Heck, Analyst

Great, thank you.

Laura Clark, CFO

Sure.

Operator, Operator

And your next question comes from the line of Vikram Malhotra with Mizuho. Your line is open.

Vikram Malhotra, Analyst

Thanks for taking the question. During your last meeting, you mentioned this might be the best time to acquire. What is the theoretical total addressable market for acquisitions at a stabilized yield of X, and how do you feel about the opportunities?

Michael Frankel, Co-CEO

We don't see the opportunity set having shifted. Rexford's business model is based on a unique market opportunity of almost 2 billion square feet of product with an infill Southern California, over 1 billion square feet of it built prior to 1980, offering opportunities to create value by buying many legacy assets. We're going to cautiously scrutinize investment opportunities in this market environment but focus on the best available opportunities for shareholders.

Vikram Malhotra, Analyst

Could you give more color on the decision to take away the three-year guide? What specifically changed in the last three months prompting you to pull the guide?

Michael Frankel, Co-CEO

We are really good at industrial real estate in Southern California, creating value in our asset class. We're less skilled at predicting the economy's direction and external factors impacting tenant decision-making. We believe this is more prudent to focus on the business at hand, providing annual guidance where we have better visibility and transparency. This does not reflect concerns about our market or tenant base, but is simply a focus on executing our strategy.

Vikram Malhotra, Analyst

Just a couple numbers questions. Given the high sublet volumes across the West Coast, do you mind giving us the percentage of your portfolio that is sublet? And what are the near-term trends in rent spreads?

Howard Schwimmer, Co-CEO

In terms of subleasing, this past quarter, subleasing in our portfolio came down to about 30 basis points of our occupied square feet, which is down from 60 basis points last quarter. The amount of product in our portfolio that was actively on the market for sublease at the end of the second quarter was 1.5 million square feet, which is now down to 1.3 million square feet. So we see this as a bright spot in the market when those numbers come in.

Laura Clark, CFO

Regarding leasing spreads we see quarter-to-date, they're aligning with our expectations. Our guidance implies spreads in the 40% net effective area and 25% cash area for 4Q.

Operator, Operator

And your next question comes from the line of Samir Khanal with Evercore ISI. Your line is open.

Samir Khanal, Analyst

Regarding the Inland Empire, the West was still down about 3%, but you saw a bit of an improvement from the prior quarter. Are you seeing some improvements there, or is it bottoming or stabilizing?

Howard Schwimmer, Co-CEO

Our average product size in the market is 30,000 square feet, therefore it's performing much differently than the broader market which is experiencing rent declines primarily in larger spaces. In the Inland Empire, we are not seeing significant declines in the rent for our smaller spaces, under 50,000 square feet, which is encouraging.

Samir Khanal, Analyst

Are you seeing any signs that the broader market in Southern CA is stabilizing, or are there any positive indicators?

Laura Clark, CFO

In the third quarter, we saw the smallest declines in rent in the San Fernando Valley, Orange County, and San Diego markets. Conversely, we saw accelerated declines in mid-counties, particularly in the San Gabriel Valley. For smaller markets, decline has been less compared to larger square footage.

Howard Schwimmer, Co-CEO

Regarding tenant behaviors, we don’t see tenants shedding space in any significant way. In fact, they continue to lock in strong annualized contractual rent bumps, which are positive indicators for future demand.

Operator, Operator

And your next question comes from the line of Richard Anderson with Wedbush. Your line is open.

Richard Anderson, Analyst

Can you comment on the linearity of market rent changes? Is it a linear exercise where when we see something stop declining, it's a good sign that we are moving towards stabilization?

Michael Frankel, Co-CEO

We expect to see some normalization after the significant rent increases during the pandemic. We will likely see moderate rent declines and some gains in specific submarkets. It's difficult to predict the exact moment when rent growth will kick in strongly, but tenant health within our portfolio remains very strong.

Richard Anderson, Analyst

How do you underwrite the next redevelopment and repositioning project given the current market environment?

Michael Frankel, Co-CEO

We take a granular bottoms-up approach when considering redevelopments. We assess the current rents and the trends, ensuring each project delivers solid returns.

Richard Anderson, Analyst

What is the status of the CFO hiring process?

Michael Frankel, Co-CEO

We're making great progress in the hiring process and will share updates as soon as we have definitive answers. We're excited about the direction this will take the company.

Operator, Operator

And your next question comes from the line of Brendan Lynch with Barclays. Your line is open.

Brendan Lynch, Analyst

On LL Flooring, were they on your watchlist? How many tenants currently are on the watchlist?

Laura Clark, CFO

They were on the watchlist due to the bankruptcy. Overall, we have less than 10 tenants on our watchlist, and our bad debt levels continue to remain very low.

Brendan Lynch, Analyst

Can you discuss the characteristics of the assets you have sold year-to-date?

Howard Schwimmer, Co-CEO

They were primarily multi-tenant projects that were management intensive and projected no further growth. The recent sale was a 25,000-square-foot building where the cap rate averaged in the low 4s, which was very favorable. These assets indicate a shift towards reducing intensive management or capital needs which would not produce incremental value.

Operator, Operator

That concludes our question-and-answer session. I will now turn the call back to management for closing remarks.

David Lanzer, General Counsel

On behalf of the company and our Board of Directors, thank you for joining us today. We wish you a great rest of the quarter, happy holidays, and we look forward to reconnecting next quarter.

Operator, Operator

Ladies and gentlemen, this concludes today's call. We thank you for your participation. You may now disconnect.