In a recent edition of The Wall Street Journal, Joseph Dobrian wrote an article titled, “Panel of Experts Views REIT Stocks as a Key Part of an Investment Portfolio”. In that article Dobrian wrote:
In uncertain economic times, a stock’s dividend is often regarded as more important than the market price of its shares. REIT stocks – since REITs normally pay out almost all of their profits as dividends – are thus an important part of an investment portfolio for uncertain times.
And based upon the latest (October 31, 2011) FTSE NAREIT Equity REIT Index (here) there are 123 Equity REITs with a combined $403.43 billion market capitalization paying an average dividend of 3.61%. Within this broad based REIT Index, there are a number of sector and sub-sector operators that focus on differentiating property types and geographic preferences. These diverse REIT platforms enable investors to build real estate allocations based upon specific differentiation strengths – including credit ratings, dividend durability, and balance sheet management. As explained in the WSJ article by Joseph M. Harvey, president and chief investment officer at Cohen & Steers (CNS):
A reason to invest in REITs is the current shortage of quality yield in the marketplace. The dramatic monetary stimulus – the printing of more money in the U.S., the U.K., and other countries – has stimulated interest in real assets: investments that can protect your portfolio from the effects of inflation. Real estate can do that.
Within the various equity REIT sectors, there are a variety of differentiators that provide risk-aligned investment strategies; however, dividends are one of the most well-defined strengths. And since REITs disburse almost all (90%) of earnings (to avoid taxation and to please investors), hard assets with durable dividends have become a very popular alternative investment group. In other words, a bond will provide you with yield, and security – but a REIT stock will provide you with yield, plus it’s likely that the value will increase.
STAG Industrial Inc.
There is a close correlation between a REITs “margin of safety” and its dividend yield. I have written several articles about many of the “safe margin” REITs including Federal Realty (FRT) (here), Realty Income (O) (here), and National Retail (NNN) (here) – all of which derive their differentiation strengths on sustainable dividend performance. These three “great repeatable” investment models are all strategically focused on risk-aligned fundamentals that include diversification (of income, location, and industry) and strong balance sheet management. And because of these sound well-balanced fundamentals, these three REITs provide for an exceptional “margin of safety” resulting in an extraordinarily reliable and safe dividend yield. Conversely, when one or more of these “margin of safety” attributes becomes dilutive, there is a compromise to asset quality and a direct multiplier to yield. In other words, the higher the risk, the higher the return.
STAG Industrial, Inc (STAG) is one such equity REIT that has a well-defined investment model built on its differentiated strength of yield. Unlike the above named “flight to quality” REITs, STAG’s competitive advantage is its focus on Class-B assets and secondary markets. Unlike many of the REITs and Institutional buyers fighting to gain stakes in larger markets with trophy assets, STAG’s strategy is to acquire properties in smaller markets where there is less competition and higher yield. And with a focus on the industrial sector, STAG aims to invest capital for higher returns in second tier markets where there is less occupancy and rent volatility. This simple, risk-averse model is built on market niche differentiation that has resulted in accretive dividend yield.
Formerly known as STAG Capital Partners, the predecessor company has been around since 2004. STAG Industrial Inc. closed on its IPO in April 2011 (just eight months ago) when it generated around $205 million (in gross proceeds). The offering included 13,750,000 shares of common stock priced at $13 per share. Since the IPO, STAG has utilized around $309 million in total debt and the company recently announced the closing of 2,760,000 shares of Series A Preferred Redeemable (at 9.0%) stock. Issued at a price of $25.00 per share, the gross proceeds of $69 million will be used to reduce the revolving credit facility (down to zero) and fund upcoming acquisitions.
Since and before STAG’s April IPO, the senior management has closed on around $1.5 billion in “big box” assets. And since the April IPO, STAG Industrial has closed on around $84 million in assets (or around 1.2 million square feet). The current asset base consists of 101 assets in 26 states. Many of the REIT’s assets are located in the Northeast, Southwest, and Midwest. Here is a snapshot of the geographic footprint. Click to enlarge:
This diverse geographic asset platform has resulted in a growing and stable yield-enhanced portfolio with a variety of industry groups. These industry classification groups provide increased diversification within the differentiated risk-aligned platform. Here is a snapshot of the leading industry classifications. Click to enlarge:
With around $580 million assets under management, STAG has grown (in eight months) to an attractively diverse operating model. And although the markets are secondary, the Boston-based REIT has many primary tenants with sound operating fundamentals. Because of the lower rental costs associated with Class-B space, many industrial users are attracted to facilities with lower occupancy costs. In addition, many such users tend to stay longer since moving costs and business interruption costs are expensive relative to relocating a “critical function” facility. Consequently, these stable occupancy metrics make STAG less volatile with more predictable cash flow generators. Here is a snapshot of STAG’s Top 10 Tenants (based on revenue):
As compared with smaller single tenant leased assets with 15 to 20 years of lease term, the “big box” industrial tenants typically execute leases of around 5 years or less. However, STAG has a weighted average portfolio lease terms of almost 6 years. And
because of the risk profile associated with short-term leased assets in secondary markets, there is a greater return (higher cap rate) threshold. As stated in STAG’s most recent third quarter results, the average cap rate for new investments is 9%. In addition, STAG has utilized a variety of debt sources and this flexible leverage pool enables STAG (and its investors) to grow its dividend with some attractive yield enhanced FFO. The combined moderate leverage (around 40% debt to un-depreciated book value) and low debt to EBITDA (around 5x) make STAG one of the lowest leveraged REITs in the peer (industrial) group. In addition, STAG has recently pursued attractive fixed-rate non-recourse funding with a life company lender. STAG has utilized this strategic non-recourse lender for around six different SPE (special purpose entity) loans and the increased leverage (around 62%) has provided some attractive yield enhanced spreads. Here is a snapshot of some of STAG’s relevant balance sheet metrics:
And as previously mentioned, STAG recently announced a new preferred stock placement and here is a summary of the REIT’s current liquidity base:
Since the IPO, STAG has closed on around $84 million in assets. Many of these Class-B facilities were acquired at or below market cost. For example, the chart below lists some of STAG’s recent acquisitions and the sample group has an average acquisition cost of less than $40 per square foot. With such below market (cost) acquisition pricing, it would be extremely difficult (if not impossible) for a STAG tenant to replicate today’s low cost occupancy rate. Furthermore, because of very little competition in these secondary markets, STAG is able to act like a “bigger fish in a small pond”. This results in opportunistic transactions as evidenced by the summary of some of STAG’s most recent transactions:
As reported in STAG’s most recent quarterly results, the growing “big box” investor has a pipeline of around $450 million of product. This means that the small cap REIT with around $580 million in “big box” assets could grow to become a billion dollar REIT in a very short time frame. This robust pipeline of Class-B product could further enhance the Income Statement with highly accretive new properties – making the differentiated model much more risk-averse!
STAG’s peer “big box” REIT group consists of some larger Industrial REITs; however, the clear “differentiation” strengths are lease expirations and dividends. As evidenced below, STAG has around 20% of its leases expiring by 2013 and the peer group (referenced below) has around 36.7% of leases expiring at the same time. In addition, STAG recently reported that its Q3 occupancy was 92.2% (up from 91% last quarter) and its YTD retention (leases renewed) rate was 87.6%.
In my opinion, lease retention is critically important for this analysis as many industrial leases are around 3-5 years in term (STAG’s weighted average lease term is 5.6 years). And based upon the snapshot below, STAG’s revenue (and dividend) is less subject to reduction (based upon the expirations of STAG and the peer group). Click to enlarge:
As mentioned above, dividends are most important for a dividend investor and STAG has clearly identified its fundamental competitive strength. With the latest third quarter results, STAG posted around $6.6 million in FFO with a core FFO multiple of 9.2x. Conversely, the high yielding dividend stock is paying around $1.04 per share or 10.2%.
So this single tenant, secondary market REIT has built a successful business model on a sustainable, less volatile platform. Compared with the peer group (and most other equity REITs), STAG has an exceptionally strong dividend. Here is a snapshot of STAG’s dividend and the Industry Peer Group:
Clearly STAG has a well-defined higher yielding REIT model and its risk-return structure is defined more by its return than its risk (attributes). Conversely, risk is what separates an investment operation from a speculative one and it is the perception of that inherent risk that formulates an opinion about a given investment choice.
In many instances a high “margin of safety” is correlated to a lower yielding alternative and a “riskier” investment is correlated to a more speculative one. However, the world is not black or white and STAG is a perfect example of a REIT with a sound investment platform AND a high dividend yield. As explained by Ben Butcher, CEO at STAG Industrial:
STAG (Single Tenant Acquisition Group) believes that the binary risk inherent in single tenant properties tends to create market inefficiencies and the opportunity to acquire assets at attractive relative values. On investment parameters such as lease term, market size and tenant credit, we believe that the world is not ‘black and white’ but rather shades of ‘grey’. The common use of decision rules in the net lease market is a reflection of a ‘black and white’ view of the world – substituting analysis for decision rules allows the investor to perceive the shades of ‘grey’ and make better informed investment decisions.
In summary, STAG Industrial Inc. is off to an exceptional start and its flexible capitalization and robust acquisition strategies are leading indicators of growth. In addition, the $10.04 (per share) stock price is trading around 23% below the 52-week high (of $12.98) and there is plenty of room for growth. The select acquisitions (referenced above) provide further support that STAG is buying assets “on the cheap” and the market rent metrics are further evidence of a sustainably attractive income and growth. Asset selectivity is very good and the prospectus for continued pipeline fulfillment looks promising.
Although the gold star SWAN (sleep well at night) acronym is only used for a select group of “dividend challengers” (Seeking Alpha Author, David Fish (here) publishes a monthly “Dividend Challenger” Report), I have identified a new acronym (and shade) to consider called STAG Investing.