Published by Nicholas McCullum on May 16th, 2017
For investors seeking yield, the real estate industry is a great place to look.
Intuitively, this is not surprising. Real estate owners collect predictable income from their tenants. Thus, the real estate business is qualitatively geared for business owners that want to collect periodic income.
This characteristic extends to the security level. One of the best ways for retail investors to gain exposure to the real estate industry is through real estate investment trusts – or REITs, for short. REITs are required by law to pass the majority of their income to shareholders as dividends.
STAG Industrial (STAG) is one example of a REIT that looks to be a very attractive investment right now. The company’s current dividend yield of 5.3% is nearly 3x as high as the average yield in the S&P 500.
Further, STAG Industrial pays monthly dividends (rather than quarterly). This is highly beneficial for retirees and other investors who rely on their dividend income to cover life’s expenses.
Because of the trust’s high yield and monthly dividend payments, STAG Industrial has the potential to be a great investment for income-oriented investors.
This article will analyze the investment prospects of STAG Industrial in detail.
STAG Industrial is a REIT that specializes in industrial commercial real estate. The trust became publicly-traded in 2011 after spinning off from its predecessor, STAG Capital Partners (formed in 2004).
Since the IPO, STAG Industrial has grown substantially – from 105 buildings initially to its current asset base of 324 buildings in 37 states rented to 279 tenants.
More details about STAG Industrial’s current business model can be seen below.
Source: STAG Industrial Investor Presentation, slide 2
The trust specializes in owning and operating single-tenant industrial real estate properties. Most REITs view single-tenant properties as highly risky. This creates mispriced assets, which STAG can then add to their portfolio at attractive valuations.
Most REITs view single-tenant properties as highly risky – and this is true, to an extent – but this creates mispriced assets which STAG can then add to their portfolio at attractive valuations.
Source: STAG Industrial Investor Presentation, slide 3
Since single-tenant properties are riskier than multi-tenant properties, investors should be rightly concerned about the impact of vacancies on STAG’s bottom line.
So how does STAG Industrial mitigate this risk?
The trust owns a diversified portfolio of single-tenant assets, which has the same aggregate effect as owning multi-tenant properties. The trust’s focus on diversification at both the portfolio and enterprise level helps to generate stable, predictable cash flows that can be passed onto investors.
Source: STAG Industrial Investor Presentation, slide 7
STAG’s stated goal is to grow its portfolio by 25% per year. While that seems like a lofty goal, STAG has a robust acquisition pipeline exceeding $1.9 billion. The company raises capital to fund these acquisitions through debt offerings and an at-the-market (ATM) equity sale process.
To identify additional acquisition opportunities, STAG Industrial has a very precise selection process.
Of 1,250+ potential transactions that passed the initial triage stage in 2016, STAG Industrial invested in only 35 properties at a weighted average capitalization rate (net operating income divided by market value) of 7.9%.
Source: STAG Industrial Investor Presentation, slide 6
Moving on, the next section will discuss the growth prospects of STAG Industrial.
STAG Industrial’s growth since its IPO in 2011 has been impressive from both a fundamental and an investor return perspective.
Fortunately, this real estate trust still has a strong growth runway.
Take its most recent earnings release, for instance: STAG saw full-company core funds from operations (FFO) increase by 27% compared to the same period a year ago. On a per-unit basis, STAG saw core FFO increase by 5.1% (partially offset by the trust’s ATM equity issuances, which dilute existing shareholders).
Looking ahead, STAG will likely continue to grow at a similar mid-single-digit clip. The trust still has a very small market share in its target market of real estate assets, leaving plenty of room for expansion.
The size STAG Industrial’s target asset universe can be easily determined by working backward.
First, narrow the aggregate real estate industry to only industrial real estate properties (~$1 trillion). Of these industrial properties, only about half (~$500 billion) are single-tenant, as STAG desires. Of this $500 billion of single-tenant industrial properties, only about half – or $250 billion – are of high enough quality to merit an investment from STAG Industrial.
Amazingly, STAG Industrial has a market share of this $250 billion target market of less than 1 percent.
If this explanation was hard to visualize, I encourage you to consider the following diagram.
Source: STAG Industrial Investor Presentation, slide 4
STAG Industrial’s small market share and willingness to own single-tenant industrial properties will ensure that the trust has plenty of opportunities to expand over the years to come.
Competitive Advantage & Recession Performance
As mentioned already, STAG Industrial’s main competitive advantage is its willingness to venture into the single-tenant industrial real estate space. The perceived risk of this class of real estate, though mitigated by STAG’s diversification, causes assets to be mispriced and STAG’s internal rate of return to be higher.
It is difficult to assess how recession resilient STAG Industrial is because the REIT was not a publicly-traded entity during the financial crisis of 2007-2009.
With that said, STAG is currently well-positioned to withstand the next economic downturn.
The REIT is well-capitalized, with 64% of its balance sheet financed with common equity and 4% with preferred equity.
Source: STAG Industrial Investor Presentation, slide 15
STAG Industrial also has some imminent opportunity to further improve its balance sheet. Namely, upcoming debt maturities give STAG the potential to meaningfully reduce its interest expense.
The company’s most expensive debt (as measured by weighted average interest rate) expires in 2017 and 2018. The REIT will almost certainly be able to refinance this maturing debt at a more attractive interest rate.
Looking further out, the trust’s remaining debt maturities are a healthy combination of low-interest and long yield.
Source: STAG Industrial Investor Presentation, slide 16
With all this in mind, STAG Industrial appears well-poised to endure any future recessions.
Valuation & Expected Total Returns
Future returns for STAG Industrial’s shareholders will come from changes in the company’s valuation, dividend yield, and growth in the trust’s per-share funds from operations.
Valuing REITs is different than corporations because earnings are not a meaningful indicator of a REIT’s underlying earnings power. For REITs, earnings-per-share are highly depressed because of the company’s large depreciation and amortization charges.
The simplest way for investors to value REITs is to compare their current dividend yield to their historical dividend yield. STAG Industrial currently pays annual dividends of $1.41 (divided into monthly installments of $0.1175), good for a yield of 5.3% based on the trust’s current unit price of $26.38.
The following diagram compares STAG Industrial’s current dividend yield to its historical dividend yield.
STAG Industrial’s dividend yield is on the low end of its historical range. Thus, the REIT appears to be trading at a slight premium to its historical valuation based on dividend yield alone.
With that said, one of the reasons why STAG Industrial’s dividend yield is lower than normal right now is because the company has been reducing the pace of its dividend growth. STAG’s most recent dividend increase was by less than 1%.
Looking at other metrics – such as the price-to-FFO ratio, the REIT equivalent of the price-to-earnings ratio – STAG Industrial appears to be trading at a discount to its peers in the REIT industry.
Source: STAG Industrial Investor Presentation, slide 17
Based on fundamental metrics, STAG appears to be attractively valued and valuation expansion might provide a slight tailwind to the REIT’s future shareholder returns.
Other than dividend payments and valuation changes, the remainder of STAG Industrial’s future shareholder returns will be driven by growth in the underlying company’s earnings power, as measured by FFO per unit.
Looking at STAG’s historical growth as a publicly-traded entity can help to estimate the future growth rate of the trust’s funds from operations.
In 2012 (STAG’s first full year as a publicly-traded entity), the trust reported funds from operations of $0.88 per unit. In 2016 – the most recent fiscal year – STAG Industrial reported funds from operations per units of $1.26 – which represents a CAGR of 9.4%.
In the long run, I expect this rapid rate of growth to slow. STAG Industrial’s FFO per unit will likely increase by 4%-6% over full economic cycles.
To conclude, the REIT’s expected shareholder returns will be composed of:
- 5.3% dividend yield
- 4%-6% annual growth in funds from operations
For expected shareholder returns of 9.3%-11.3% before the effect of valuation changes.
STAG Industrial has two characteristics that will immediately appeal to income investors: a 5.3% dividend yield and regular monthly dividend payments.
Despite the company’s impressive performance in recent history, this REIT is still an attractive value at today’s price.
Thus, STAG Industrial makes a good addition to a high-yield portfolio because of its high dividend yield, monthly dividend payments, and leadership in the single-tenant industrial real estate market.