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The Good Times Won't Last Forever, But Terreno Realty Is Doing Everything Right

May 05, 2020 11:00 AM ETTerreno Realty Corporation (TRNO)14 Comments

Summary

  • Logistics real estate benefits from unique yet effective tailwinds.
  • Terreno Realty has capitalized on the tailwinds to deliver incredible 18% bottom line growth since 2016.
  • It trades very expensively, but management is doing the responsible thing by aggressively issuing stock.
  • Looking for a helping hand in the market? Members of Best Of Breed get exclusive ideas and guidance to navigate any climate. Get started today »

Terreno Realty Corp. (NYSE:TRNO) is a high-performing industrial REIT. It has been able to realize what can only be described as phenomenal rent growth, and due to the positive fundamentals, it has been rewarded with a generous share price valuation. While I do not think that the fundamental outperformance of industrial REITs will continue indefinitely, TRNO’s management team is taking the right steps to ensure that the high valuation of the stock will lead to long-lasting benefits to the company's balance sheet. Due to the REIT's valuation, I am neutral on shares.

These Are (Very) Good Times

TRNO owns 220 industrial buildings located in six major U.S. markets:

(Source: 2019 Q4 Presentation)

Industrial properties are mission-critical due to being an important part of the supply chain - I am sure that most can understand this. But what many may not know is that industrial properties are very valuable due to a unique phenomenon. For starters, TRNO’s portfolio has the highest population density per square mile as compared to peers:

(Source: 2019 Q4 Presentation)

The high population density creates the strong and understandable tailwinds of perennially rising housing prices and ever-increasing housing supply. Increasing housing supply leads to declining industrial supply:

(Source: 2019 Q4 Presentation)

To give an indication of how this affects industrial properties, we can see below how decreasing inventory at San Francisco has led to incredible increases in rent since 1997:

(Source: 2019 Q4 Presentation)

Industrial properties are not as pretty as high-class real estate or housing properties. But they don’t have to be to benefit from strong neighborhood demographics. Industrial properties have significantly lower rent per square foot as compared to neighboring retail and housing properties, which leads to accelerated and persistent rent growth as compared to other sectors. You can say that it pays to own the ugly duckling in

25 Stocks I Like More Than TRNO

TRNO didn't make the cut - the Best of Breed portfolio features over 25 stocks rated strong buy or even conviction buy.

Some investors start by looking at valuation with a stock screener, and from these cheap companies try to find any that they can justify buying. I instead start with an assessment of quality, and only from the highest quality companies do I begin to search for value. My goal is to not only beat the market but to also do so with a high success rate.

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This article was written by

Julian Lin profile picture
30.06K Followers

Julian Lin is a top ranked financial analyst. Julian Lin runs Best Of Breed Growth Stocks, a research service uncovering high conviction ideas in the winners of tomorrow. 

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Comments (14)

Value_Investor_2019 profile picture
@Julian Lin Thanks for the article. Do you think $TRNO is a buy now?
Julian Lin profile picture
@abdullah_value_investing_only it is certainly more buyable than when I wrote this article!
Value_Investor_2019 profile picture
@Julian Lin Even though the price is now higher?
Julian Lin profile picture
@abdullah_value_investing_only The price is 10% higher, but the fundamentals have improved by much more. That said, I have no position in $TRNO, as I am seeing better opportunities in the REIT sector.
Beyond Saving profile picture
Having bought it long ago, I'll admit that I've become a bit emotionally attached as it has routinely been one of my strongest performers and very rarely having any significant downside. At $45, below 30x FFO it was an easy buy. I'll admit it is back in that range where TRNO often is- "I really want it, but it is expensive!". In the grand scheme, TRNO is about average priced relative to its own history.

I think you underestimate TRNO's ability to keep putting up such large same-store stats. Their SSNOI isn't really such a useful metric because they buy properties that have leases close to expiration and have fallen well under market. So the SSNOI "growth" is really more TRNO just raising the rent up to market value. It looks impressive because the leases are 7-10 years old and over that length of time, no escalator is keeping pace with the SoCal industrial market.

In another 10-years, it is very reasonable to expect that the LA ports will still be the largest industrial ports in the country. It is very reasonable to expect that LA building regulations will become even more cumbersome (betting on government getting bigger is always safe, especially in LA), the pressure from non-industrial uses will become even more severe and the leases that TRNO is signing today will be just as far under market rent as the ones they are replacing. In the market they have, it isn't so much industrial demand pushing prices, it is all the people who want to live in SoCal, bringing in money to pay for so many non-industrial uses that has substantially constrained supply.

TRNO's ability to navigate the market, work with the bureaucrats, and keep getting a larger share of a heavily constrained supply means their crushing performance can easily last another decade or more. So yeah, the valuation is rich however you look at it, but you will not be mad at yourself in 10-years if you buy. I add whenever the price drops below 30x FFO. A good steady performer with low beta that helps smooth out some of my more wild bets.
Julian Lin profile picture
Thanks @Beyond Saving
I find it interesting that on one hand you buy WPG at deep discounts but seem to support an investment in TRNO at under 30 times FFO simply because it always trades expensively :)

Note that acquisition cap rates for industrial properties keep declining - that can only be supported by massive rent increases. That isn't sustainable - rent will not be able to increase indefinitely at the pace in the past. After all, at some point rents for industrial properties begin to rival retail/residential rent...

I like that TRNO management aggressively issues equity. If industrial REITs experience a reckoning, then TRNO is my preferred bet.
Einherjar profile picture
Bought REXR on the dip...the ESS of industrial real estate
William Darusmont profile picture
Great article, I recently bot REXR based on a lead from Brad Thomas...this confirms his view and adds great information on the Debt/EBITDA vs stock sales..
Thank you!
Julian Lin profile picture
Thanks for reading!
WSLegend profile picture
I don’t invest in REITS with a yield under 5%!
Julian Lin profile picture
It's not a bad mantra.
There's many REITs yielding in excess of 5% right now!
Philipsonh profile picture
@WSLegend
I used to be like you, but this pandemic has changed my outlook
dramatically. A product paying 3%, for example, but with a share price holding up very well, is better for my mental health than a product paying 6% and dropping 50-60% or more. It is too unnerving.
Thanks.
William Darusmont profile picture
6% isn't so bad...10%+ IS...those mandatory payouts are brutal in these times when they should be preserving capital. Look st these as of Friday: CLDT suspended, STWD 14.4%, BXMT 10.4%BRX 10.6%; SKT 23%!!! - pass!; SPG 14.7%!; KIM 11%; OHI and IRM 10%; PMT 9.8%; OLD 11.9%; LADR 16.9% and OXLC 48.9%...monthly payer and mgmt just indicated NO divvie for AT LEAST next three months.
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