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E-Commerce Trend And Warehouses At Half Price

|About: Griffin Industrial Realty, Inc. (GRIF)
Summary

Griffin Industrial Realty (NASDAQ: GRIF) is trading at $37.65 (as of 7/29/2019) and is potentially worth 62% to 127% more.

Has the potential to expand its 3,645,000 sqft industrial/warehouse portfolio.

Griffin would be a great accretive acquisition target for a large-cap industrial REIT or private equity firm.

Overview

Griffin Industrial Realty’s (NASDAQ: GRIF) real estate portfolio has a private market value 62% to 127% higher than today’s $37.65 share price (as of 7/29/19). I believe this price-to-value gap exists because the market is not giving Griffin enough credit for its warehouse portfolio and the company’s ability to grow its warehouse footprint. At today’s price, I believe that the warehouse portfolio would be a great accretive acquisition for either a real estate private equity firm or a large-cap industrial REIT.

Real Estate Portfolio and Development Pipeline

Griffin’s real estate portfolio consists of warehouses, office buildings, and land parcels. In 2014, Griffin sold off its historic nursery business and since then, the company has converted some of its land parcels into income-generating warehouses.[1] Sometimes Griffin will use 1031 exchanges to purchase land and/or buildings outside of Connecticut in areas such as Lehigh Valley, PA, and Charlotte, NC.[2] As a result, Griffin has become more of a pureplay warehouse company.

As of May 31, 2019, Griffin owns 3,645,000 sqft of warehouses across Lehigh Valley, Hartford, and Charlotte.[3] These warehouses are 94% leased with the only vacancy being a newly built 134,000 sqft warehouse in Lehigh Valley.[4] The remaining portfolio includes 433,000 sqft of suburban office buildings in Hartford, CT and 3,345 acres of land.[5] Griffin is also actively developing warehouses using its “land bank”. For example, the company is currently building a 283,000 sqft warehouse in Charlotte, NC.[6] After this project is completed, Griffin will own and operate 3,928,000 sqft of warehouse and 433,000 sqft of suburban office for a grand total of 4,361,000 sqft of income-generating buildings.

I believe Griffin can further grow its industrial portfolio. The company recently closed on 45 acres of land in Charlotte, NC to build a 500,000 sqft warehouse.[7] The company also owns land parcels in the New England Tradeport, which is their Connecticut industrial park. I estimate that Griffin can build roughly 1,000,000 sqft of warehouse in the New England Tradeport, 440,000 sqft of which is shovel ready:

  • The 220 Tradeport Drive facility is currently leased to Ford Motors. This 12 ½-year lease includes an option for Ford to build an additional 54,000 sqft.[8]
  • 100 International Drive currently has a 304,200 sqft facility and the site is approved for a 450,000 sqft warehouse. If the warehouse were expanded, an additional 145,800 sqft would be added.[9]
  • 110 Tradeport Drive is a shovel-ready parcel of land and would add 240,341 sqft if the site were developed.[10]
  • Griffin also owns a large parcel of land in the New England Tradeport (the upper left-hand corner of the map below). Based on the size and footprint of the existing buildings, I believe Griffin can build between 500,000 to 750,000 sqft of warehouse.

Source: Griffin Industrial Realty New England Tradeport Master Plan

Adding all this together provides a range between 940,000 sqft to 1,190,000 sqft. Assuming 1,000,000 sqft figure, these projects would increase the warehouse portfolio to 5,428,000 sqft.

Source: Own work. Acreage, sqft figures can be found in Griffin’s recent 10-Q filing and May 2019 Investor Presentation. Development pipeline figures are my own estimates.

Sum-of-Parts Valuation

I will value Griffin’s portfolio as a sum-of-parts based on cap rates and $/sqft methods. The valuation will be based on my assumptions about the warehouse leasing net operating income (NOI), the suburban office leasing NOI, and the asset value of its land holdings.

I believe the warehouses will likely generate $23.0 million of NOI after the 134,000 sqft Lehigh Valley warehouse is done leasing. In the 12 months ending 2/28/2019, Griffin generated $23.5 million of NOI for the whole company.[11] This NOI figure includes its office leasing NOI and Griffin’s nursery NOI. Office leasing NOI per sqft tends to be higher than warehouse leasing NOI per sqft and since Griffin’s office buildings are only 74% leased, office NOI will likely be a small figure. I will assume the office will generate $2 million in leasing NOI, based on office being 11% of the overall portfolio. Additionally, Griffin has stated that nursery NOI is about $1.0 million.[12] $23.5 million less $2.0 million less $1.0 million provides $20.5 million of warehouse NOI. The $20.5 million NOI figure does not include the lease up of the 134,000 sqft Lehigh Valley warehouse, any rent escalators, and leasing NOI from Griffin’s 2018 new leasing of 304,000 sqft of warehouse space in the New England Tradeport. Given this, I believe warehouse NOI will be a higher figure and $23.0 million of NOI is a fair assumption.

Given a $23.0 million NOI, a cap rate method can be used to provide an asset value for the warehouse portfolio. According to CBRE’s Cap Rate Survey in H2 2018, industrial Class A warehouses trade at a 5.07% cap rates and industrial class B warehouses trade at 5.98% cap rates on a nationwide basis.[13] The survey also states the following about industrial/warehouse cap rates in Griffin’s submarkets:

  • Charlotte industrial cap rate: 5.25% - 5.75% cap rate [14]
  • PA 1-87/81 Corridor cap rate: 4.75% - 5.00% cap rate [15]
  • Hartford, CT warehouse falls into the Tier 3, Class A industrial category: 6.02% average cap rate [16]

Based on variables such as warehouse age, ceiling height, truck bays, applying the class A cap rate to Griffin is appropriate. I believe that a 6.0% cap rate is conservative. Griffin’s warehouse portfolio is valued at $383.3 million using a 6.0% cap rate and $460 million using a 5.0% cap rate.

For reference, public REITS such as Prologis, Duke Realty, and Liberty Property Trust trade at an average of $111 per sqft and an average 4.8% cap rate (see chart below). Based on my analysis, Griffin’s warehouse portfolio trades at a 10.2% cap rate after adjusting for its office buildings and land bank. It is worth mentioning that the comparable group generate $5.18 of NOI/sqft on average while Griffin generates $5.86 NOI/sqft. When a portfolio can charge higher rent and earn higher NOI/sqft, it is generally a sign that the underlying real estate has a better location and better features. Thus, one can argue that Griffin’s portfolio is of a higher quality than the portfolios of public comps.

Source: Own work, data can be found on each company’s respective quarterly supplemental report.

Another way to value the warehouse portfolio is by using a $/sqft method. In 2018, Blackstone bought the warehouse portfolio of a company called FRP Holdings for $358.9 million at roughly $92/sqft. FRP Holdings portfolio generated NOI of $5.41 per sqft based on an acquisition price of $21.1 million and a deal price of $358.9 million.[17] Applying the same metric would value Griffin’s warehouse portfolio at $335.3 million. In July 2019, Prologis acquired Industrial Property Trust’s (IPT) 37.5 million SQFT portfolio for almost $4 billion or about $107/sqft.[18] Applying $107/sqft metric would value the portfolio at $390 million. According to IPT’s 10-K, the portfolio generated $4.74 NOI/sqft in FY2018 and the deal was transacted at a 4.4% cap rate.[19] Again, one can argue that Griffin’s portfolio is of higher quality than IPT’s since Griffin generates $5.86 of NOI per sqft. These private warehouse transactions imply a $335.3 to $390.0 million range using a $/SQFT method.

As mentioned earlier, I am assuming a $2.0 million NOI figure for the Hartford office buildings. According to CBRE’s H2 2018 cap rate survey, suburban office buildings trade at 7.91% cap rates and using a conservative 10.0% cap rate, this office is valued at $20.0 million. This translates to about $46/SQFT, which is well below the replacement cost of these office buildings.

The land holdings are trickier to value. As shown earlier, Griffin owns 227 acres of “Master-Planned Industrial/Warehouse Land where they can readily build warehouses. I believe a $125,000 per acre value is appropriate, implying a value of $28.4 million.

The 314 acres of “Significant Commercial/Mixed-Use” acres are valued at $80,000 per acre. There have been sales from time to time of similar land at $100,000 per acre. However, land is not perfect; sometimes the topography is uneven, or a portion of the land is wet and cannot be developed on. Thus, only part of the 314 acres is useful and an $80,000 per acre value will imply a roughly $25.1 million.

The “Entitled Residential Land” is carried on the book value at $9.6 million. I will use this figure in the valuation as Connecticut residential development is currently unexciting.

The nursery operators in Connecticut had an option to buy the nursery land for $9.5 million. The operator of the Florida nursery has an option to buy the nursery land and operation for $3.4 to $3.9 million. Since the Florida operator has gone bankrupt, I will use a $2.5 million estimate for the Florida asset. This will value the nursery business at $12 million.

Griffin also owns 890 acres of “Other Land Holdings”. This collection includes land that is suitable for solar development. Griffin recently closed on a deal to sell 280 acres to a solar developer for $7.7 million or $27,500 per acre. There was a separate agreement to sell to a solar developer for $7.8 million. The second deal fell through. Aside from the solar parcels, Griffin sold 116 acres within this collection for $866,000 in 2019 or $7,465 per acre. Thus, this collection of land has a value between $7,465 to $27,500 per acre. Using $10,000 per acre as an average, the Other Land Holdings have a value of $8.9 million.

In total, we arrive at an $84 million of future proceeds for Griffin’s land parcels and since it would take time to sell off all the land, I think that a $60 million present value is fair.

6.0% Cap Rate - $383.3 million for the warehouse, $20 million for the office, $60 million present value for the land parcels, $7.7 million of recent proceeds from land sales and $10.0 million for the new 283,000 sqft construction of warehouse in Charlotte, NC. The sum-of-the-parts equals $481 million before net debt of $124.6 million. A net asset value of $356.5 million divided by 5.07 million shares outstanding leaves us with a private market value of $70.31 per share.

5.0% Cap Rate - $460 million for the warehouse, $20 million for the office, and $60 million for the present value of the land parcels, and $7.7 million of recent proceeds from land sales and $10.0 million for the new 283,000 sqft construction in progress warehouse in Charlotte, NC. The sum-of-the-parts equals $557.7 million before net debt of $124.6 million. A net asset value of $433.1 million divided by 5.07 million shares outstanding leaves us with a private market value of $85.43 per share.

As of July 29, 2019, Griffin trades at $37.65. Thus, there is 62% to 127% potential upside assuming different cost bases and using different cap rates (see below for Back of the Envelope Calculation).

Source: Own work, $92/sqft assumption is based on FRP Holdings transaction. $107/sqft assumption is based on Prologis acquisition of IPT. 5.0-6.0% cap rate range is based on CBRE H2 2018 Cap Rate Survey. 10% office cap rate is a conservative estimate based on CBRE H2 2018 survey.

Acquisition Target

Private equity firms, namely Blackstone, and public industrial REITs have been actively acquiring warehouse portfolios in anticipation of the shift of retail from brick-and-mortar to e-commerce. In order to fulfill these orders that are increasingly going to Amazon.com and other e-commerce vendors, retailers have raced to build out local and regional distributions centers. Between 2016 to 2019, Blackstone made 11 acquisitions totaling 375 million sqft of warehouse, paying an average of $101/sqft. Griffin’s warehouses would be a great accretive acquisition for any of the public industrial REITs. REITs such as Prologis and EastGroup trade with dividend rates between 2-5% (Prologis at 2.57% and EastGroup at 2.37%), have a cost of debt capital of about 3.6%, and have a weighted average cost of capital in the 3-4% range. These REITs can easily issue equity as currency to acquire Griffin.

Alignment of Incentives

While some may jump to the conclusion that Griffin’s large insider ownership is a sign that the company will behave poorly, my observations tell me otherwise. Management has historically done a good job of creating shareholder value. During the annual meeting, it was clear that management has been frustrated with the persistently large gap between the stock price and intrinsic value. Shareholders have pestered the management team about the large gap between price and intrinsic value. Management is aware that this gap exists and has communicated that they want to close this gap. Based on this feedback, I believe that the management team is aligned with minority shareholders in achieving a higher share price. In the meantime, management continues to create value through operating cash flow, warehouse development, and sale of land parcels. Another important distinction is that the family owns nearly half of the company. During the annual meeting, they mentioned that they underwrite investments based on absolute returns rather than looking at investment yields vs weighted-average-cost-of-capital. I believe the former is more conservative while the latter may lead to bad acquisitions later in a cycle.

High G&A Expense

Investors have criticized the company for having too much G&A expense. I have spoken with shareholders who have attended the last three annual meetings. The feedback is that the shareholder base has been very vocal about the large SG&A and management has kept the SG&A flat in the last few years while still growing the business. They have also provided a detailed breakdown of the SG&A in response to shareholder inquiries. The G&A expense totals about $7.9 million.[20] Public companies pay on average $2.5 million for public company costs such as audits, filing fees, director compensation, etc.[21]

Griffin’s undeveloped land incurs property taxes, which are mitigated by over $1 million of rental revenue from leasing to farmers. However, this expense is captured in the G&A expense. While the largest components of the G&A are salary and benefits, Griffin elects to keep certain leasing personnel inhouse which saves them money.[22] Griffin also expenses the salary of VP of construction in the G&A. In comparison, large REITs tend to outsource this function and capitalize the expense. Griffin has an active development pipeline and some of the G&A can be considered growth-related.

Low Cap Rates and Low Vacancy

This is a legitimate concern as valuation are high due to low industrial vacancy and low cap rates. Part of this is due to the good economy and another part of this is due to the structural trend of how companies are using more warehouses to fulfill retail orders. One can hedge out some of the risks here with puts in Prologis, Duke Realty, or other large-cap industrial REITs.

Assessment of Gabelli’s Criticism

According to the most recent proxy statement, Gabelli Funds, LLC owns 32.3% of the company. In the past, Gabelli has criticized the company for dilution from options and not buying back shares. However, the family already owns 45.8% of the company and combined with Gabelli’s 32.3% position, this leaves a float of only 21.9%. While share buybacks would have increased shareholder value, it would have also left the company overly concentrated in land parcels in Hartford, CT. Instead, the company decidedly diversified its portfolio by developing the Lehigh Valley and Charlotte warehouses. The Lehigh Valley investments have been home runs in that they cost the company $84 million and are now potentially worth over $150 million. On top of this, Griffin used non-recourse mortgages and has achieved much higher levered returns as a result. I think the return on equity is likely 4 to 5 times cost and is roughly mid-20s. By diversifying the portfolio, Griffin has become more “investable” by making it easier to put a cap rate on the leasing NOI.

Gabelli’s criticism of the company likely stems from how his fund has been a shareholder prior to the 2008-09 Recession. Gabelli owned 29% of the company as early as 2007. I empathize with how the Fund has owned the stock for 12 years without much profit to show for it. At the peak of the housing bubble in 2007, Griffin only owned 1,061,000 SQFT of warehouse and 382,000 SQFT of office compared to the 3,645,000 SQFT of warehouse and 433,000 SQFT of office today. Any long-term value investor would be extremely frustrated if their shares stayed flat for 12 years despite such an amazing transformation.

Debt Capital Structure

A neat feature of Griffin is that the company uses non-recourse mortgages to finance their buildings. Non-recourse mortgages are loans secured by collateral, which in Griffin’s case is their warehouses. If Griffin were to default on a loan, foreclosure would occur on the property level rather than on the company level. Griffin has over a dozen non-recourse mortgages with no significant maturity until 2025. This means that Griffin can selectively return the assets back to the bank in a crisis if there has been an impairment on certain buildings. Another way to think of this is that Griffin has a dozen “silos of debt” that are independent of each other. If one silo fails, the bank can’t come after the rest of the assets. The mortgage holders are confined to the silo that they lent to. The mortgage interest rates are fixed and range between 3.79% to 5.09%. The gross amount of the mortgage and credit lines is $143.5 million and as of this writing, total net debt is about $124.6 million.

Summary

Griffin currently has 62% to 127% upside potential, if it were to be taken over by a public industrial REIT or a real estate private equity firm. If Griffin does not get taken over, I believe deep value is its own catalyst. Griffin currently generates over $10 million of cash flow a year (about $2 per share). Most warehouses have 2-3% annual rent escalators in their leases. Griffin’s NOI should grow by this amount without any new development. On $23 million of NOI, a 2% NOI increase divided by a 6.0% cap rate generates $7.7 million of additional value, which is an additional $1.50 per share of value creation. In addition, Griffin is actively developing warehouse which creates a few millions of value each year. I believe that Griffin can grow its private market value by $4 to $5 a year due to its operating cash flow, rent escalation, and new developments. If it takes 3 years for Griffin to trade up to 90% of NAV, we can underwrite to a 26% compound annual growth rate.


Sources

[1] Griffin Announces Closing on Sale of Imperial Nurseries Jan 9, 2014

[2] Griffin Annual Meeting Presentation May 2019, pg. 26

[3] Griffin Annual Meeting Presentation May 2019, pg. 4

[4] Griffin Annual Meeting Presentation May 2019, pg. 10

[5] Griffin Annual Meeting Presentation May 2019, pg. 4

[6] Griffin Annual Meeting Presentation May 2019, pg. 4

[7] Griffin Announces Closing on Land Purchases Jul 22, 2019

[8] Ford Resets Auto-Parts Hub to Windsor Feb 9, 2018

[9] Griffin Land completes 304,200 s/f built-to-suit facility for Tire Rack Inc at New England Tradeport Nov 4, 2009

[10] 110 Tradeport Drive

[11] Griffin Annual Meeting Presentation May 2019, pg. 17

[12] Griffin Annual Meeting Presentation May 2019, pg. 30

[13] CBRE North America Cap Rate Survey Second Half 2018, pg. 17

[14] CBRE North America Cap Rate Survey Second Half 2018, pg. 21

[15] CBRE North America Cap Rate Survey Second Half 2018, pg. 20

[16] CBRE North America Cap Rate Survey Second Half 2018, pg. 20

[17] FRP Holdings Schedule 14A, pg. 64

[18] Prologis to Buy Warehouse Owner Industrial Property Trust Jul 15, 2019

[19] Industrial Property Trust Form 10-K FY2018, page 55

[20] Griffin Annual Meeting Presentation May 2019, pg. 19

[21] The True Costs of Being Public: More Than You Think Nov 18, 2011

[22] Griffin Annual Meeting Presentation May 2019, pg. 19

Disclosure: I am/we are long GRIF.

Additional disclosure: This article expresses solely my opinions, is produced for informational purposes only and is not a recommendation to buy or sell any securities. Investing comes with risk to loss of principal. Please consider consulting a professional before putting any capital at risk.