Avoid These Industrial REITs
Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Industrial real estate investment trusts (REITs) own portfolios of industrial buildings, which they lease or sell for profit – profit which is passed on to shareholders in the form of dividends. I’m going to get right to the point: this is a bad sector to be in, both in the short and long term. Manufacturing in the United States has been in a long-term decline for decades, and recent economic uncertainties (such as the various fiscal cliffs) have not helped share prices or profitability in the past year. Industrial companies need to be adding jobs or changing space for big industrial buildings to lease up, and those jobs have not been appearing for the industrial sector like they have for retail. In general, the industrial sector appears to be an unsafe place to invest. For a more granular look, I have chosen two of the big industrial REITs to compare: Duke Realty (NYSE: DRE) and Prologis (NYSE: PLD).
One of Duke’s major assets is its property diversification. The company operates a combination of industrial, healthcare, and office buildings. Unfortunately, their stated goal of an asset mix of approximately “60% bulk industrial, 25% suburban office and 15% medical office” is too industrial-heavy, given the issues I have outlined above. Digging into the financials, Duke is carrying a pretty hefty debt load (its debt-to-equity ratio is 1.48, according to YCharts). Duke’s revenues have been in decline since 2009, and interest makes up almost a quarter of the company’s expenses (reflecting that heavy debt load). The 4% dividend yield is tempting but may not be sustainable based on the negative earnings per share (EPS): -$.04 for the trailing twelve months and -$.51 for calendar year 2011. Funds from operations (FFO) is a metric, commonly used by REITs, which functions similarly to EPS, but does not include gains/losses from real estate sales and ignores depreciation. FFO is popular as an alternative metric due to the belief that the depreciation schedule used to arrive at EPS ignores the continuing value of commercial real estate owned for investment purposes (for more information on this topic, read this article). Duke's FFO for 2012 was $1.00 per share, which may indicate a more sustainable platform for the dividend.
Prologis has a surprisingly modest amount of debt, with $11.8 billion (as of December 2012) for a debt/equity ratio of .73 (according to YCharts). That is a low rate of leverage for any REIT (and especially compared to Duke). This allows Prologis to be more aggressive in acquiring additional real estate; recently, they partnered with the Blackstone Group to purchase a 17 million square foot industrial portfolio. Even with the strong balance sheet and recent acquisitions, I am concerned that Prologis has been steadily losing money. Of the past 20 quarters, only 8 have seen a positive net income for the company. Other metrics haven’t been stellar either, with EPS clocking in at -$.04 for the trailing twelve months, according to Morningstar. FFO has been flat since Q3 of 2011, with Prologis earning between $.40 and $.45 per share. Especially given the company’s rising revenues - $1.5 billion in 2011 grew to a little over $2 billion in 2012 – the poor EPS and net income and the flat FFO numbers are concerning.
The bottom line
My general rule is to avoid businesses that are inconsistently turning a profit (both of these companies) or carrying a heavy debt load (Duke). I don’t trust the dividend sustainability for Prologis, as it just instituted its first dividend since 2008. These are not good vehicles for your investment at this time.
On a broader note, REITs will have difficulty taking on additional debt if/when the Fed tightens up the money supply. Commercial real estate’s reliance on the Fed keeping credit flowing is a major weakness overlooked by dividend-hungry investors seeking “easy” money from a REIT. For some more reading on this topic, please see the paper by John Krainer of the Federal Reserve Bank in San Francisco at http://www.frbsf.org/publications/economics/letter/2013/el2013-12.html. Especially given general uncertainty about fiscal policy, avoid industrial REITs until further notice.
Michael Douglass has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!