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Well managed businesses are rare, especially in the real estate space. There are hundreds of public REITs and few stand out in their areas of expertise. Some of the largest names such as Realty Income (O) tout long, established histories that investors point to for validation. Some look to copy proven business models, such as Netstreit (NTST). Others struggle to earn their stripes, such as Global Net Lease (GNL). Great REITs are few and far between.
Today, we will follow up on STAG Industrial (NYSE:STAG), a pure play industrial net lease REIT. As of our prior coverage, we felt industrial REITs were still thriving, but STAG was overvalued along with much of commercial real estate. STAG focuses on industrial properties across the domestic United States. We have covered STAG in depth in prior articles, describing the portfolio and strategy in depth. Today, we are going to cover two topics, STAG’s dividend growth and fourth quarter earnings results.
Who is STAG Industrial?
STAG is on a short list of net lease REITs that focus on industrial properties. STAG owns 568 properties as of Q3 2023 totaling approximately 112 million square feet. STAG is a member of the S&P MidCap 400 and has a combined enterprise value of $8.9 billion. Out of STAG’s nearly 600 properties, approximately 75% are single tenant industrial and 25% are multitenant industrial. Without diving too far into STAG’s portfolio, the assets are spread across industrial heavy states such as Illinois, Ohio, Texas, North Carolina, and South Carolina.
STAG
STAG is a misunderstood REIT, often compared to other industrial landlords such as Prologis (PLD), First Industrial (FR), and Rexford (REXR). These REITS operate more sophisticated business models than STAG. Their capital is recycled more actively with a greater emphasis on speculative development projects, joint ventures, and asset/property management services. While STAG also develops properties, there is a heavier focus on low risk, build to suit projects as opposed to large scale speculative development. Remember, STAG is a net lease REIT, meaning it operates a buy and hold business model. STAG is in the business of acquiring and holding leased, cash flow producing properties. As developers, these other REITs rely more heavily on the “build, lease, sell, and repeat” business cycle. These more desirable properties trade at extremely aggressive capitalization rates which do not make sense for STAG to acquire in large quantity. Similarly, STAG typically doesn’t invest in Tier 1 markets such as Inland Empire or New Jersey. STAG hunts for yield. As a result, STAG is less risky, but also less profitable. STAG will not trade with an FFO multiple similar to industrial peers such as PLD. For reference, compare STAG’s FFO multiple of 15.7x to PLD’s 23.8x.
However, STAG is more proactive in their asset management efforts than many net lease competitors. Most net lease REITs run very lean operations which amount to “buy and hold” portfolios. There is limited reinvestment back into the asset under the guise that the typical net lease tenant will do their own capital improvements to help their business. STAG operates a development platform and a low-profile value-add operation which are successful and lucrative.
In the most recent annual report, STAG provides three recent case studies from their value add business. STAG recently acquired a spec, Class A industrial facility in a submarket of Louisville, KY in September 2022. STAG acquired the asset vacant from a developer and began the hunt for a tenant. Now, for most net lease REITs, this profile of acquisition does not happen. As I mentioned, REITs like STAG are in the business of acquiring leased assets. Retenanting vacant properties is a risky maneuver for a net lease REIT seeking stable cash flow. Industrial leasing remains an area of expertise for STAG, especially in their established markets. Within four months of acquisition, STAG was able to lease the building on a five year term to an investment grade tenant. STAG secured the lease at a 27% premium to market rent. This is one example of STAG’s management team adding value to their assets.
Dividend
STAG pays a level monthly dividend of $0.1233 per share corresponding to a dividend yield of approximately 4.0% based on recent share prices. STAG pays a monthly dividend giving shareholders the benefits of monthly rent checks. The structure is common amongst net lease REITs. Other monthly payers include O, Agree Realty (ADC), and Gladstone Commercial (GOOD). STAG has raised the dividend annually since IPO in 2011, starting their march towards dividend aristocrat status.
Now, let’s address the elephant in the room regarding STAG. The dividend growth has been anemic, with raises in the fraction of cents per share. Most recently, STAG increased the monthly dividend from $0.1225 per share to $0.1233 per share, an increase of less than 1%. Despite strength in the industrial market and strong leasing spreads, STAG has not transitioned internal success to shareholders in the form of dividends. This point garners more criticism of STAG than any other.
REITs must distribute a certain portion of their income to shareholders as dividends to maintain their favorable tax status. There is flexibility afforded by accounting and financial mechanisms providing REITs with options as to how they can spend their money. Some REITs opt to send this capital straight to the dividend, stretching the payout ratio, but giving more capital to shareholders. GOOD is a prime example, having long maintained one of the highest yields and payout ratios in the net lease sector. However, GOOD was one of the first to cut their dividend. In contrast, other REITs opt to minimize the amount of capital that goes to the dividend, instead internalizing the capital for other uses. These other uses can vary but may include reinvestment into new or existing properties. Additionally, REITs may opt to use this excess capital to reduce leverage or even initiate a share buyback program.
STAG has opted for a combination of both. STAG’s payout ratio is 73.9% based on cash available for distribution, meaning the REIT has around $100 million remaining after dividends paid. This capital is used to fund value add projects, expansions, or new developments, all of which amount to growing net asset value over time. STAG actively reinvests capital into their assets, the benefit of which is often not reflected in short term financial performance. However, over time, the increasing quality of the portfolio will act as a tailwind for leasing spreads and appreciation. I would argue the STAG of today is vastly different than the REIT pre-COVID because of sector tailwinds and successful asset management efforts. Compare STAG’s price performance against other net lease REITs with industrial investments.
STAG has also reduced leverage and solidified their financial situation. For example, as of year end 2019, STAG’s fixed charge coverage ratio was 4.8x, compared to the current year FCCR of 5.7x. While macroeconomic conditions may have deteriorated, STAG has acted conservatively to grow the distribution and improve their financial position.
However, if STAG wishes to gain favor amongst retail investors, dividend growth needs to accelerate. Gone are the days of STAG reporting 2%-3% same store rent growth. Recent leasing spreads have been impressive and STAG should deliver dividend growth which at minimum aligns with annualized FFO per share growth. However, in a world of REITs who have stretched themselves thin, STAG remains committed to building a moat.
Earnings Review
STAG recently reported fourth quarter and full year earnings. To report the top level highlights, core FFO per share came in $0.01 above estimates at $0.58 per share. Fourth quarter FFO was $0.04 above FFO from the same quarter prior year. Same store NOI growth increased 6.8% year over year, faster than the 5.3% growth reported in the third quarter. Occupancy increased by 0.6%, reaching 98.2% across the portfolio. Across the board, STAG’s earnings were strong, supported by tailwinds in industrial real estate.
On the earnings call, STAG relayed some important information regarding the business. Most notably, STAG has reported stellar cash rent spreads for newly executed leases. As assets are newly delivered, acquired speculatively, or left vacant, STAG is responsible for expeditiously finding new tenants. Beyond the lost cash flow, STAG must also cover the previously “netted” expenses such as insurance, maintenance, and property tax while the property is vacant. STAG has been able to secure tenants over a period of months with rental rates up to 50% over expiring leases. As tailwinds have mounted over the past five years for industrial investments, STAG has begun to feel the full effects filling their sails. Bill Crooker, CEO, announced a similar enthusiasm.
“2023 was one of the best operational years we had as a public company. We produced record leasing spreads and record cash same-store NOI. These leasing spreads and same-store NOI growth were driven by continued market rent growth in our portfolio. 2023 market rent growth for our portfolio was high single digits. On national, market rent growth has generally experienced a degree of normalization, non-coastal markets outperformed coastal markets in 2023.”
Crooker reported 31% and 44% for cash and straight-line leasing spreads, respectively. Additionally, year to date 2024 cash leasing spread data remained strong at nearly 30%. These spreads are significantly higher than those of retail or office assets owned by other net lease competitors. These cash leasing spreads could possibly force STAG to raise their dividend more significantly in the future. The payout ratio further declined from 78% at the end of 2022 to 75% at the end of 2023. Given the extraordinary increase to industrial rents coming out of the pandemic, it’s likely that STAG could see similar cash leasing spreads for several years. As long term leases begin to expire, new tenants will come in at a market level substantially higher than lease signed a decade ago. STAG provided guidance that cash leasing spreads will likely land between 25% and 30% for the year.
Looking forward, management had positive sentiment around the acquisition market, a critical piece of STAG’s growth. Crooker announced a $3.1 billion pipeline with wider spreads than typical. The confidence is encouraging given management teams from across the sector expressed diverse opinions on acquisition opportunities in 2023.
This year, we’ve had a lot more confidence in the acquisition market than we did at this time last year. Our pipeline sits at $3.1 billion. Pipeline consists about 10% to 15% portfolios, 15% to 20%, 25% of developments, redevelopments, value add. With respect to the acquisition guidance, it is wider than a typical year. Like I said, we do have a little bit more confidence than we did last year. We’re underwriting more transactions. We underwrote more transactions in January than we did all of Q4 2023. With all that being said, we are expecting acquisitions to be more back-end weighted, just given some of the uncertainty in the market. But we’re seeing a lot more deals today. It gives us more confidence than we did last year.
There was no mention of dividends on the call. While the reduced payout ratio and improved financial metrics were discussed, the dividend was left in the cold. Shareholders deserve a raise, especially as STAG’s management team continues to report double digit same store rent growth. Unless STAG can show shareholders that the capital is being used productively and quantify the added value, more growth to the payout would be appreciated by investors.
Conclusion
Despite our complaints around the dividend, STAG remains a well-managed REIT marching towards a bright future. STAG is more than halfway to achieving dividend aristocrat status and has apparently chosen the path of least resistance. For shareholders, we continue to enjoy a monthly dividend that grows expectedly. While the dividend growth has been weak, total returns have been sustained by STAG’s productive investments back into the assets.
STAG’s fourth quarter earnings were exceptional, reporting growth across business segments and an optimistic outlook for 2024. STAG’s management team has earned trust as the REIT continues to improve their financial position, grow the dividend, and proactively build the portfolio.
