3 Of My Favorite REITs

We want to highlight three of our picks for long-term investors.

What Will Drive FFO and AFFO Per Share Higher?

Rexford (REXR) is delivering hard through same-property NOI growth and leasing spreads. Same-property NOI growth drives FFO and AFFO per share higher immediately. However, 2022 only gets part of the benefit. The higher NOI per share achieved in Q3 2022 sets a higher baseline for all of 2023, but 2022 only gets 2 quarters (Q3 and Q4) of the higher NOI.

Likewise, the huge leasing spreads REXR is reporting will be driving dramatic growth in revenues and same-store NOI for 2023. When REXR enters Q1 2023, they will have the benefit of the dramatically higher revenue rates signed throughout all of 2022.

Leasing Spreads

Leasing spreads are getting even better. In REXR’s mid-quarter presentation, the leasing spreads appeared to be dropping moderately. However, September saw some massive spreads on new leases driving values for the quarter to new all-time record highs. We highlighted this in our update on REXR for REIT Forum members.

Think REXR can’t find tenants in September? Tenants disagree. I’ve charted their leasing spreads by quarter since the start of 2016:

Correct me if I’m wrong, but they just beat the exceptional spreads from Q2 2022. GAAP rates were up 89%. Cash spreads were 63%. Who can try to spin 63% cash spreads as a negative?

Just a quick note here. When management provided an update in September, the leasing spreads were not yet this high. In the early part of Q3 2022, they were only at 69% for GAAP and 54% for cash. That still would’ve been a pretty good quarter, but the actual results for the full quarter turned out materially better.

To be fair, eventually, leasing spreads will slow down. They cannot compound at that rate indefinitely. However, investors should recognize that the AFFO per share and the dividend (funded by AFFO) reflect the current level of rent collected on the portfolio. Many of these leases will expire over the next few years and be replaced at dramatically higher levels.

Dramatic growth in cash flows is already built in because the real estate is leased below market rates. That’s before we consider the continual need for additional industrial real estate to support the shift to e-commerce. While e-commerce does not require retail space, it requires far more industrial space per dollar of sales. That’s an enormous tailwind for the industry and it should continue to play out across the next decade.

Other Great Industrial REITs

We already provided a research report on Terreno (TRNO). We prepared the report before TRNO had a 10-Q posted, but TRNO had previewed some of their metrics for the quarter. The numbers were excellent and bear out the same story we see here with Rexford.

We’ve also seen a bump for Prologis (PLD) since Prologis reported Q3 2022 earnings.

We have positions in all three of these REITs. We began building our positions back in May 2020. However, we had few opportunities to add. We bought a little TRNO in February 2021, but that was the only purchase until May 2022.

From May 2022 through the end of 2022, we purchased industrial REITs 10 times. Our purchases were split between TRNO, PLD, and REXR.

I’m not just writing about the industrial REITs, I’m buying them. Those 10 purchases starting in May 2022 add up to $124,622.60. That’s just the last 10 purchases, it doesn’t count the two prior purchases with a total value of $19.789.81.

Industrial REITs are down since the middle of May, but that was only the first two purchases for 2022. We also had three for June, three for September, one for October, and one for December.

You can see each of those positions here:

We own positions in several other equity REITs as well, but we wanted to isolate just the industrial REITs.

Note: As of 01/05/2023, we spent a little over $10k starting another industrial REIT position that isn’t added to the image.

The Bottom?

I think there’s a respectable chance that we’ve already seen the bottom hitting for REXR and TRNO around $50 and the bottom for PLD around $100. Shares could go lower, but the valuation is already excellent.

Dividend Growth

Yield-focused investors are ignoring growth.

They ignore TRNO raising the dividend by 17% in 2022, 17% in 2021, 7% in 2020, and 12% in 2019.

They ignore REXR raising the dividend by 31% in 2022, 11% in 2021, 16% in 2020, and 15% in 2019.

Sure the dividend yield is low today, but they have the embedded cash flow growth to generate significant increases over the next several years.

Price to NAV

TRNO is listed as a premium to NAV, but I believe the consensus NAV estimate fell too far.

That’s using the share price as of 01/05/2023 with consensus NAV estimates as of 01/05/2023.

In my opinion, Wall Street is overreacting with the reduction in NAV estimates. While cap rates have increased on industrial real estate, rents also increased significantly. Higher rents can offset a good chunk of the bump in cap rates, and these REITs were running with very low leverage.

Low Consensus Estimates

We believe that Wall Street underestimated TRNO’s AFFO growth rate.

We previously argued the 2024, 2025, and 2026 estimates for Terreno were too low:

We claimed (correctly) that the negative growth projected for 2023 to 2024 was absurd as the leasing escalators alone would provide significant growth. That is before considering the benefits of their huge leasing spreads as old leases expire.

Wall Street responded by significantly increasing estimates for those years. I pulled the estimates again in December. :

Those estimates are up $.22, $.09, and $.18 per share.

Of course, the estimates continue to change. You’ll notice that the newer estimates (as of 01/05/2023) actually create a much less volatile growth rate. I added arrows to signal which values were higher or lower than they were in December:

The estimates for 2023 and 2024 were down slightly, but the estimates for 2025 and 2026 were up significantly. This is a more reasonable estimate of the growth rate for TRNO.

Relative to our initial call that Wall Street was getting the estimates wrong, the estimates for 2024 through 2026 were increased by:

The difference between the initial growth rate and the current projected growth rate is the difference between growing AFFO per share by 67.7% or 93.4% from 2021 to 2026. That’s a material difference when it comes to compounding. Despite that improvement, TRNO is only up 3.2% since we initially called out those bad estimates.

Conclusion

Industrial REITs remain a very attractive area for investment. This is not about comparing dividend yields to Treasury yields. This is about evaluating the long-term growth potential of the REIT. We have several picks outside the industrial REITs also, but industrial REITs have been our largest area for equity REIT additions over the last seven months.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.