Real Estate Investment Trusts aren’t in a great place right now. Elevated inflation and interest rates are keeping investors away from an industry that performs best during times of low inflation and cheap funding.
After all, most have rent escalators that are capped to protect tenants against high inflation. Also, high inflation is hurting consumer spending and related economic sectors.
Year-to-date, REITs are down roughly 4%, using the Vanguard Real Estate ETF (VNQ) as a proxy. This includes dividends. The S&P 500 is up 13.8%.
While I believe that challenges are mounting, as discussed in an article I wrote with Brad Thomas, I’m consistently looking for attractive investments.
One stock I want to highlight using this article is STAG Industrial (NYSE:STAG), an industrial REIT with a well-diversified portfolio, a >4% monthly-paying dividend, and a rock-solid balance sheet that will more than likely protect its investors against mayhem if it were to occur.
So, without further ado, let’s dive in, starting with the bigger picture!
Industrial Real Estate Is The Place To Be
During its second-quarter earnings call, the company elaborated on the strength of the industrial real estate sector. The company made the case that the industrial sector is benefiting from specific trends such as near and onshoring and the rise of e-commerce. This is the trend of companies bringing suppliers close to home.
This fueled one of the biggest investment booms in America’s history, as shown by the chart below. Manufacturing construction spending is now above $200 billion on an annualized basis.
The White House has an interactive map showing the locations of major projects and how many jobs these projects are generating.
As we can see below, projects cover the entire Rust Belt, the South, and tech hotspots like California and Arizona (semiconductors).
Going back to STAG’s comments, despite a slight increase in national vacancy rates to approximately 3.7% in the second quarter, demand for industrial real estate remains robust.
However, tenants are taking more time to evaluate their space needs and are increasingly opting for third-party logistics firms to manage their supply chains, avoiding significant investments in large new spaces. After having researched dozens of top-tier transportation and real estate companies in recent months, I can confirm that this is indeed the case.
In STAG’s case, this shift has impacted demand for recently constructed large-footprint buildings. Some competitors like Prologis (PLD), the world’s largest industrial landlord, rent buildings to third-party logistics providers, which lowers the risks tremendously. STAG has these capabilities as well, which is why I am not very worried about these trends.
Having said that, other data confirms the company’s comments. Using Wells Fargo data, industrial real estate remains one of the best places to be. While the vacancy rate has increased a bit, it remains below pre-pandemic levels, accompanied by solid rent growth. However, prices have started to decline. The same goes for the net absorption rate.
Although the current situation is not alarming, the combination of the economic slowdown and the continual expansion of industrial supply is not ideal. Despite the fact that the majority of the supply is for projects with long-term growth potential, such as re-shoring, I think that a further decline in economic growth could negatively impact rent growth and occupancy rates in the upcoming quarters.
What Makes STAG So Special
With a market cap of $6.2 billion, STAG is the 9th-largest industrial REIT in the United States. However, I need to add that this includes self-storage companies.
Among pure-play industrial players, it is the fourth-largest operator.
As of the second quarter, the company has 558 properties across 41 states, covering more than 111 million square feet. The average weighted lease term is 4.6 years. A quarter of its buildings are multi-tenant buildings.
Furthermore, what’s interesting is that roughly 30% of the company’s assets are located within a 60-mile radius of megasite projects.
Hence, it is no surprise that the map below is somewhat similar to the White House map I shared at the start of this article.
Adding to that, half of its tenants are publicly traded companies. 84% of its tenants have more than $100 million in annual revenue. 59% of tenants generate north of $1 billion in revenue.
Renting to large players always lowers risks, as these companies tend to have better resources to withstand recessions.
Looking at the overview below, we see that the company is highly diversified when it comes to top markets, tenants, and industries. No tenant accounts for more than 2.8% of annual rent. Chicago is its largest market, with 7% of annual base rent. The air freight & logistics industry is its largest industry.
The top ten of its tenants account for just 10% of annual base rent.
On top of that, the company also has a top-tier balance sheet. As of 2Q23, it has an adjusted net leverage ratio of 4.9x (EBITDAre). EBITDAre is EBITDA adjusted for rental costs.
STAG also has close to $740 million in undrawn credit capacity and $17 million in cash.
With regard to the current environment of elevated rates, the company has no major maturities in both 2023 and 2024. Even including 2025, just 17% of its debt is due after 2025.
The total weighted average interest rate on the company’s debt is just 3.6%.
It has an investment-grade BBB credit rating.
Thanks to a solid tenant portfolio, secular tailwinds, and a healthy balance sheet, the company has plenty of room to distribute dividends.
STAG currently pays a $0.1225 per share per month dividend. This translates to a yield of 4.2%.
While this is a decent yield, the bad news is that over the past five years, the average annual dividend growth rate was just 0.7%.
Nonetheless, the company’s consistent growth and favorable financials have resulted in a more than decent longer-term total return. Over the past ten years, STAG has returned 184%, beating the VNQ by a considerable margin.
The dividend is protected by a very healthy core FFO payout ratio of 65%. In this case, I’m using 2023 company guidance.
This brings me to the next part.
Guidance & Valuation
On a full-year basis, the company expects to generate $2.25 in core FFO per share, which is the midpoint of its guidance.
Looking at the overview above, the most noteworthy adjustment to full-year guidance was the cash same-store guidance, which was raised to a range of 5.00% to 5.25%.
The positive shift was attributed to the company’s ability to enhance retention rates and a modest reduction in expected credit losses from 40 basis points to 20 basis points.
According to the company, this change not only reflects operational efficacy but also suggests its adaptability to changing market dynamics and its proactive approach to risk management.
Speaking of market dynamics, another notable guidance change was the adjustment in the retention rate, now ranging from 70% to 75% based on leases signed to date.
This adjustment is indicative of the company’s confidence in its leasing strategies and tenant relationships, aligning with its overall growth trajectory.
It also reflects the company’s efforts to maintain strong tenant relationships, which is obviously a critical element for sustainable growth and stable cash flows.
Valuation-wise, we’re dealing with a 15.4x 2023E core FFO multiple. The sector median is 11.8x.
The current consensus price target is $39.30, which is 13% above the current price. I agree with that but wouldn’t make the case that the fair value is higher.
The company’s growth is not high enough to justify a higher valuation, especially not in light of increasing macroeconomic challenges.
Also, given the company’s low dividend growth, a 4.2% yield isn’t something to get very excited about.
Hence, I will give the stock a Hold rating and suggest that potential investors looking for an entry wait for more weakness. It may not happen, but I think $30 is a great price to start buying STAG.
Again, it may not fall this far. However, if I were in the market for STAG, I would want to buy it at these levels to make the risk/reward more attractive.
At these levels, I prefer faster-growing industrial REITs like Prologis, which has a bigger focus on logistics.
Other than that, I think STAG is a terrific investment for investors looking for safe and consistent industrial REIT income.
STAG Industrial stands out amidst the current challenges facing Real Estate Investment Trusts.
Focusing on the resilient industrial real estate sector, STAG’s diversified portfolio and strong balance sheet make it a special investment opportunity.
With 558 properties across 41 states and a strategic location near major projects, STAG’s tenant base of reputable, financially stable companies ensures stability even in economic downturns.
The company’s consistent growth and attractive dividends, yielding 4.2%, have led to a solid long-term total return.
However, given economic challenges, the company’s valuation, and slow dividend growth, I give the stock a Hold rating and believe that waiting for potential weakness is the way to go here.