Why This Industrial REIT Came Out On Top by Heli Brecailo, GilverBook
Only Stockholm syndrome could explain why some investors fall in love with average or poorly performing holdings. Rather than acknowledging failure and moving on, they try to rationalize silly things and justify their choices at all costs. Eventually, both investor and company lose. Investors lose the opportunity to learn and make better investment decisions in the future, and companies lose the opportunity to learn from a disappointed investor.
That’s why we decided to assemble some straightforward REIT metrics on an Excel spreadsheet in order to make sense of the data more objectively. Numbers speak volumes, above any personal choices and preferences. Of course we have our favorites; it’s part of being human to like and dislike, and we can’t neglect looking around. But, ultimately we’re in this to make money like any REIT investor.
Yes, we were also surprised to see Terreno Realty Corporation (TRNO) come out as an Industrial REIT winner with the best overall Q2 operational performance. But, numbers don’t lie, and in Terreno’s case the financial report showcases three important growth rates: 18 percent in FFO per share (2nd place in our industrial REIT ranking), 46 percent in total revenues (2nd place), and 14 percent in dividend (3rd place). Even for the items on which Terreno doesn’t perform as well, the numbers still look good. Occupancy was at 94.4 percent (second to last) and dividend payout ratio at 59 percent (4th place) – I’ll take it. You can download the Industrial REIT ranking on our website.
Terreno Realty sticks to their guns. They aren’t looking to be everywhere in the country, but stay laser-focused on a six-coastal-market strategy. Three cities on the West Coast (LA, San Francisco, and Seattle) and three on the East (NJ/NY, Baltimore/DC, and Miami). Like Rexford Industrial, Terreno Realty is exposed to the Southern California market, the largest industrial park in the country.
Three of Terreno’s six markets present the lowest national availability rates. San Francisco, Los Angeles, and Miami represent almost 40 percent of the portfolio and have availability rates below 6 percent. On the other hand, Baltimore (27 percent of the portfolio) has among the highest availability rates. This gives us an indication of where management intends to grow its portfolio.
I also like that Terreno pursues infill markets. These are geographic locations surrounded by high concentrations of already developed land and existing buildings. For that reason, the operator usually decides not to develop but instead to revamp existing properties’ profiles by re-tenanting or making operational improvements. This is a less risky strategy for avoiding the pitfalls of ground-up development.
Also, Terreno operates with multitenant buildings, so it isn’t subject to the “binary” nature of single-tenant buildings (which are either 100 occupied or not at all). On a minor note, the multitenant aspect of the strategy also helps the company maintain exposure to several submarkets.
The vast majority of these properties are warehouses or distribution centers.
Margin of safety
Searching for a cushion in investment – as directed by the father of value investing, Benjamin Graham – increases the likelihood of gains. In Terreno’s case, the company invests in empty or partially occupied buildings in consolidated markets; renovates, redevelops, or expands them; then, sells them with gains; this provides the margin of safety that investors are looking for. Terreno is a “flipper” of Industrial properties.
Example of redevelopment in San Francisco (Littlefield)
You invest in a company for its fundamentals and strong long-term strategy, but governance can play an important role in making investment decisions. In Terreno’s case, that the majority of board directors are independent and elected every year and that the company has abandoned some anti-takeover provisions demonstrate that the shareholder is a priority. Examples of good governance like Terreno have been needed in the REIT space.
Next years’ projections
Rental rates in Industrial properties have been increasing and availability has fallen. In fact, CBRE believes that the next five years will be favorable. The only caveat is that this is the perfect moment to invest in supply, so we should expect more development. Industrial hasn’t yet reached its peak, so we can anticipate a streak of good news for the next few years until supply catches up with demand.
Although in our Industrial ranking Terreno was one of the bottom performers in internal growth, that isn’t bad news at all. While Industrial same store cash net operating income has fluctuated between 5 and 13 percent (with most yielding between 5 and 6 percent), Terreno’s increased by 5 percent. Also, Terreno’s same store occupancy advanced 70 basis points to 96.9 percent.
In general, Industrial REITs have kept a conservative debt profile and none presents total debt to total capitalization above 40 percent. In fact, the ratio fluctuates between 25 and 39 percent, putting Terreno in the bottom end of the range. This is a company that received a BBB- from Fitch Ratings, a very good sign for a growth stock. Among the growth stocks (STAG Industrial, Rexford Industrial, Monmouth Real Estate, and Terreno Realty), only Monmouth does not have an investment-grade rating from a consolidated credit agency.
The bad news is that with Terreno you pay for what you get. Among all Industrial REITs, it is by far the most expensive in terms of price-to-FFO. Further, the dividend yield has been below the peer median. While most of its peers got cheaper during the selloff, Terreno showed resiliency and kept itself together – perhaps because absolute majority of its ownership is institutional capital that refused to sell the shares. At any rate, this is definitely one of the best operational performing Industrial REIT stocks of the year.
Source: Industrial REITs Q2-15 Financials, Terreno Realty Corporation, Fast Graphs, CBRE
About the author
Heli Brecailo is the editor of GilverBook, a newsletter focused on REIT stocks. He graduated from MIT’s Sloan School of Management in 2008 and has extensive experience in managing real assets investments. He is a CFA® charterholder, and has worked in several sectors within the Financial Services Industry, including Investment Management, Investment Banking, and Commercial Banking.
Disclaimer: This is not a recommendation to buy or sell stocks. The highest-yield stocks are not necessarily the best portfolio investment choice. The purpose of this report — which is essentially a snapshot of information available on September 7, 2015 — is to reduce your stock analysis by enabling you to compare stock and sector performance. Please do your own due diligence before making any investment decision.
As of August 31, 2015, the equity REITs are constituent companies of the FTSE NAREIT All REITs Index. Companies whose equity market capitalization is lower than $100 million have been disregarded.
This report is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.
Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.