1 week Ago
leolintang/iStock via Getty Images Terreno Realty Corporation ( NYSE: TRNO ) operates within an attractive industrial property sector through investing in: warehouse/distribution facilities light industrial properties R&D facilities transshipment properties improved land For those unacquainted with TRNO, the Company targets infill locations (locations with a high concentration of already developed land and buildings) within six coastal US markets. TRNO's Q2 2024 10-Q TRNO's Investor Presentation As we can observe from the map presented in its Investor Presentation, the Company concentrates on locations within the highest-density submarkets, which is evident when comparing TRNO's portfolio to its peer average. Within this article, we will concentrate on three matters: Is TRNO the highest-valued industrial REIT? If so, do its metrics support that premium? And finally - do I consider TRNO a viable 'buy' right now? TRNO In a Nutshell Portfolio briefing As of Q2 2024 , the Company owned 292 buildings with 18.
1m sq. ft. and 45 improved land parcels with 152.
4 acres, nine properties under development and additional 35.4 acres of land without any ongoing projects, but with potential for the years to come. As mentioned before, the TRNO concentrates on six markets: Northern New Jersey / NYC LA Miami San Francisco Seattle Washington, D.
C. TRNO indicates that most of its portfolio (79%) is located within submarkets accompanied by a positive supply-to-demand relationship with either shrinking or no net new supply. TRNO's Investor Presentation That's a positive factor reflecting the strength of TRNO, as it showcases higher immunity to the industrial sector headwinds present since mid-2022.
Substantial construction finishes have resulted in a lot of new supply hitting the market since mid-2022. Combined with the cooling demand after the post-COVID rush, many markets entered the oversupply state, driving the market vacancy rate to as high as 6.5% as of Q2 2024 .
CoStar Inc. and Wells Fargo Economics Despite the highly attractive submarkets the Company targets, the abovementioned market environment certainly impacted TRNO's occupancy rate, which amounted to 96% as of Q2 2024 (vs over 98% as of Q3 or Q4 2023). TRNO's Investor Presentation Still, that's a reasonable level, and investors have nothing to be concerned about.
Please review the table below for details regarding the occupancy rate of TRNO and some of its peers. Author based on TRNO, PLD, STAG, EGP, and FR It's also worth mentioning that the oversupply state negatively impacts landlords' negotiating positions, decreasing the pace of rent growth. That is evident in the market data, as the annual market rent growth pace decreased to levels not recorded since 2014.
CoStar Inc. and Wells Fargo Economics Nevertheless, TRNO manages to deliver significant cash rent increases upon lease expirations. As the Company stated: Cash rents on new and renewed leases commencing during the three months ended June 30, 2024 increased approximately 45.
9% on approximately 0.5 million square feet and 18.9 acres of improved land; tenant retention during the three months ended June 30, 2024 was 56.
4% for the operating portfolio and 61.2% for the improved land portfolio Let me introduce you to the mark-to-market effect for those unaware of the mechanics behind 45.9% growth vs the market's annual 4.
3% growth. Please remember that typical contractual rent escalators amount to low single-digit levels (annually). On the other hand, the market rent growth amounted to (on average) high single-digit or even double-digit levels, as observed in the chart below.
Therefore, as leases approach expirations, landlords can demand substantially higher rents while negotiating with previous or new tenants. The negotiating strength naturally varies from market to market and property to property, depending on the market supply-to-demand relationship and the quality of a given property. TRNO will benefit from such rent bumps in the upcoming years, as its properties' weighted average lease term (WALT) ranges from 2.
8 years to 5.6 years (depending on the market) and averages to 4.2 years overall.
That is a relatively short-term WALT, so TRNO's leases will be marked-to-market relatively quickly, substantially driving its financial stance, especially given over 40% increases recorded in Q2 2024. The market conditions are improving Although the industrial property environment remains relatively tough, some positive signs suggest the upcoming improvement in the supply-to-demand relationship. Such a conclusion can be derived through two metrics: construction starts keep on shrinking, which will lead to substantially less new supply hitting the market in the upcoming years Q2 2024 brought the first net absorption improvement in seven quarters, suggesting the demand is starting to pick up its pace The above metrics suggest that the industrial property sector will quickly turn from oversupply to undersupply, further improving TRNO's portfolio exposition regarding the supply-to-demand relationship.
This improvement will improve TRNO's negotiating position, ensuring higher rent growth and occupancy rate. Another factor to consider is the potential for interest rate cuts. According to CME Group's FedWatch tool , the market expects noticeable cuts to occur by the end of 2024.
CME Group Should those expectations materialize, TRNO will benefit in two primary areas: transactional market: under the high interest rate environment, the pricing gap between buyers' and sellers' expectations is relatively wide, negatively impacting the transactional market activity. With interest rate cuts, that gap will narrow, improving TRNO's ability to source attractive deals as the Company's investment activity revolves around acquisitions cost of debt: TRNO has a relatively high exposition to floating-rated debt (25.8% of total debt), so the lower interest rate environment would benefit its day-to-day costs related to servicing debt With that said, let's move on to TRNO's balance sheet.
Reasonable credit metrics, but low dividend coverage TRNO's Q2 2024 10-Q There are a few things to highlight about the Company's balance sheet: BBB+ credit rating high, 7.7x fixed-charge coverage relatively high exposure to floating-rated debt relatively short-term debt maturity schedule with $100m maturities left for 2024 Although the credit metrics don't raise any substantial red flags, TRNO's dividend payments during Q1-Q2 2024 amounted to $82.57m, while its AFFO amounted to $89.
48, constituting a ~108% AFFO dividend coverage. Its forward-looking AFFO payout ratio is ~96.6%, far above what I'd like to see in a REIT.
Valuation Outlook As an M&A advisor, I usually rely on a multiple valuation method that is a leading tool in transaction processes, as it allows for accessible and market-driven benchmarking. The forward-looking P/FFO multiple stood at: 28.4x for Terreno Realty 16.
3x for STAG Industrial ( STAG ) 23.5x for Prologis ( PLD ) 21.4x for First Industrial Realty ( FR ) 23.
8x for Americold ( COLD ) 22.2x for EastGroup Properties ( EGP ) 20.9x for Rexford Industrial Realty ( REXR ) As we can see, TRNO is the most expensive industrial REIT in the presented peer group.
While the Company deserves to trade at a premium, I believe that its current size is too great. Naturally, I appreciate its portfolio quality and unique strategy, but the margin of safety is just too narrow for me. It's hard to imagine TRNO experiencing a substantial upside from the multiple expansion.
Yes, the Company used to trade at even higher multiples during the 2020 - 2022 period, but I'd tie that to the post-COVID industrial sector boom rather than the 'normal' level. To put it frankly, I would consider TRNO overvalued in 2022, but not undervalued currently. Of course, time will tell how this unravels.
Data by YCharts Investment Thesis and Risk Factors Each stock market investment is accompanied by various market and company-specific risk factors. In the case of TRNO, we could mention: low margin of safety resulting from a relatively high valuation low dividend coverage relatively high exposure to the costs associated with the high interest rate environment exposure (to some degree) to the industrial property sector headwinds Nevertheless, there's no denying TRNO's portfolio quality and the effectiveness of its investment approach. The upcoming market shifts should constitute further tailwinds for the Company.
However, I believe that there are better industrial REIT opportunities in the current market, with stronger upside potential and a higher margin of safety. Therefore, TRNO is a 'hold' for me, as I wouldn't consider it a go-to pick in the sector at its current price and risk factors. Analyst’s Disclosure: I/we have a beneficial long position in the shares of PLD, FR either through stock ownership, options, or other derivatives.
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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