E-commerce is one of those trends that is impacting just about every industry out there, even real estate. The need for more robust transportation, logistics, and delivery hubs has put a premium on industrial real estate. Two real estate investment trusts (REITS) that are prominent players in this unique industry are Prologis (NYSE: PLD) and STAG Industrial (NYSE: STAG).
For investors, the differences between these two REITs may be subtle, but those subtle differences have led to very different results. Let's take a look at why industrial real estate has been such an attractive market and which one of these two REITs is the better buy today.
Attacking a red-hot real estate market
Industrial real estate is slowly becoming one of the hottest real estate investments out there. According to CBRE's (NYSE: CBRE) cap rate survey, industrial real estate cap rates have been on the decline for most of this decade. The average cap rate for stabilized industrial assets now stands at 6.13%. Lower cap rates means that investors are paying higher and higher premiums to acquire property.
It isn't too surprising that industrial real estate -- logistics, warehouses, and distribution centers especially -- are a hot commodity. There are two primary drivers as to why this is happening:
- The rise in e-commerce is putting a premium on speedy delivery, so retailers of all walks need to have more robust logistics networks to satisfy customers.
- Over the past two decades, brick-and-mortar retailers have been reducing their inventory-to-sales ratios. There are lots of reasons why this is happening, such as lower inventory meaning smaller store footprints in high-rent areas and fewer inventory write-downs. For warehouse owners, though, lower inventory levels require stores to rely more on those same supply networks to keep the shelves stocked.
At first glance, industrial real estate wouldn't have that many differentiating factors, but there are some distinct differences in the types of properties in which these two companies invest.
Prologis' focus is on what could be called the premium end of the industrial real estate spectrum. These are assets that are located close to metropolitan areas and tend to serve as logistics hubs for overnight and same-day deliveries.
Prologis highlights the difference in its investor presentation using aggregate rents for the various property types. What it calls a last touch facility -- those in urban areas that can be used for same-day delivery -- can carry annual rent rates as high as $22 per square foot per year compared to a multi-market distribution center -- located at major highway junctions to serve many metro areas simultaneously -- that will generate about $4.55 per square foot per year.
Not only do these high-demand locations tend to have low vacancy rates, but management is also able to increase rents at higher than average rates. In its most recent quarterly report, management noted that net effective rent changes -- the increase in rental rates for a property with a prior lease of more than 12 months -- are 29% over the past four quarters. That is incredible pricing power that has led to Prologis growing its funds from operations (FFO) per share by 41% over the past five years.
STAG, on the other hand, tends to focus on redevelopment opportunities outside major metro areas. The company has a strong track record of taking vacant or underutilized assets and stabilizing them with long-term leases or making modest capital improvements to improve their appeal that it either then continues to own or package into a portfolio of facilities for sale.
Creating portfolios of facilities has been an incredibly lucrative way for STAG to generate returns. By aggregating individual properties into portfolio sales, it has been able to dispose of properties at significantly lower cap rates. This stabilize, package, and sell tactic has led to similar rates of funds from operations growth as Prologis over the past five years.
Both Prologis and STAG are similar in more than just the market they attack. If you look at their financials, they are also in good shape. While Prologis sports better numbers, both companies appear to have healthy balance sheets that should allow them to both handle any short-term issues and grow their respective businesses.