First Industrial Realty Trust: One of My Top Industrial REIT Picks (NYSE:FR)

First Industrial Realty Trust (NYSE: FR) is an industrial REIT that owned 424 properties with 67.9 m sq. ft. of gross leasable area in 19 states (June 30, 2024).

I have had the pleasure of covering FR twice since my date the journey on Seeking Alpha has begun. Both times, I assigned it a “buy” rating. To better understand the evolution of my views on FR, please see the links below:

• First industrial looks buyer as market conditions improve

• First Industrial Realty Trust lays the foundation for future success

After I published my first article on FR, I did not follow my own advice and buys as I focused on other opportunities, including a leading player in industrial property – Prologis (PLD). However, not long after the second release, FR shares saw a brief dip and then I started my job.

Some investors may find this counter-intuitive as the Company’s valuation has risen substantially from April to June 2024, but let me tell you:

1. FR has great stuff, which we’ll mention later
2. The tough market conditions surrounding FR and creating headwinds for the entire industrial property sector show even more signs of change to come than before, making industrial property players more attractive, with FR being one of the top REITs on my industrial sector list right now.

Let’s start with the latter – market change is coming

Before addressing the positives, let’s summarize the concerns

The industrial property sector has faced headwinds related to rising interest rates and oversupply in most markets. The oversupply was caused by (temporary) cooling demand, with large-scale construction completions supporting supply. The unfavorable relationship between demand and supply has led to less dynamic rent growth and a dynamic increase in the vacancy rate in the market. According to the Wells Fargo Q2 2024 report:

• the vacancy rate saw solid growth for the eighth consecutive quarter and reached 6.5% in Q2 2024
• rent growth fell to the slowest annual rate since 2014. The decline in the pace of growth is even more evident when considering quarterly changes

Q2 also brought eight consecutive quarters of net additions above 100 sq m. ft. (102.3 m sq. ft. in Q2 2024), further strengthening the supply of industrial property and thus negatively impacting the problem of oversupply.

The data mentioned above does not paint a good picture of the industrial property sector, but let’s look further and try to set some expectations for the coming years.

The night seems darkest before dawn

On the demand front, net absorptions remain well below historical standards. However, they recorded their first improvement in seven quarters, totaling 30.3 sq m. ft., which is ~triple the amount recorded in Q1 2024. This is a positive signal suggesting that tenant decision-making processes are beginning to intensify.

Moreover, industrial space under construction continues to decline, setting the stage for future supply-demand improvement. With demand picking up and cooling construction starting (expected by most industrial property REIT management teams and already reflected in the data), we are likely to see current oversupply turn into undersupply in the coming years, having a positive impact on industrial REITs. negotiating positions and business metrics (rent growth and occupancy rates).

FR’s business summary

I consider FR one of the best picks in the industrial property sector because of its attractive risk-reward ratio. The margin of safety resulting from the valuation is reasonable compared to some of its peers (we’ll discuss later).

I don’t want to get too detailed about the business or credit values ​​of FR as I have already discussed in detail in my previous coverage. However, I want to provide a brief overview of its most important numbers to provide a holistic perspective on my current investment thesis and decision to start a position in FR.

• significant rent increases: for context, market rent growth has substantially outstripped rent growth resulting from contractual rent ladders, which are typically in the low single digits. As a result, industrial property players can significantly increase their rents when the lease expires (through editions or leases with new entities). For example, FR has seen cash rent increases of 58.3% and 43.4% in 2023 and Q2 2024, respectively. This will continue as FR’s historical leases expire in the coming quarters/years .
• occupancy rate: As previously noted, oversupply headwinds have driven the market’s vacancy rate higher, which is reflected well in the recent occupancy records of top industrial REITs. Please see the table below for details on the occupancy of the FR and some of its teams.

• dynamic growth of FFO and DPS: FR’s DPS posted ~8% CAGR from 2019 to 2023, and I don’t think that dynamic will change, especially given FR’s capex and updated FFO per share guidance in 2024. Its current guidance assumes an FFO per share ranging from $2.57 to $2.65, representing an increase of 3 cents in the middle. If FR were to hit its mid-point guidance, that would represent 7% year-over-year FFO growth per share.
• balance sheet strength: dividends are supported by a reasonable, “sleep sound” balance sheet with a BBB credit rating, 4.4x fixed charge coverage and no debt maturity until 2026. On the other hand, its overall debt maturity schedule is on relatively short term at 4.3 years on average and has exposure to interest rate risk due to its outstanding ~11% floating rate debt.

Assessment perspectives and risk factors

Market and company-specific risks accompany every stock market investment. In the case of FR, it is worth mentioning:

• The high interest rate environment has a negative impact on the Company’s cost of capital as it has some exposure (~10.8% of outstanding debt) to variable rate debt. Moreover, such an environment causes a wide gap between the expectations of buyers and sellers, slowing down the transactional market.
• there is no definite answer to how long the oversupply problems will remain. Such an environment has a negative impact on FR’s ability to increase occupancy and sign new / expiring leases
• the valuation remains attractive compared to some of its peers and the Company’s valuation has increased substantially over the past two months. At the same time, industrial property players are relatively valued, so investors accustomed to retail-oriented REITs may find that off-putting.

With that said, let’s move on to the evaluation perspective. As an M&A advisor, I typically rely on a multiple valuation method that is a leading tool in transaction processes because it allows for affordable and market-based benchmarking.

The prospective P/FFO multiple stood at:

• 21.6x for FR
• 23.6x for PLD
• 16.7x for STAG Industrial (STAG)
• 28.3x for Terreno Realty (TRNO)
• 23.9x for Americold (COLD)
• 22.4x for EastGroup Properties (EGP)

Since we last covered FR, the P/FFO multiple has appreciated ~70 bps. This therefore suggests less room for potential upside from multiple expansion. Previously, we indicated that the 22-23x P/FFO range is achievable for FR.

However, with the even more likely positive shift in the supply/demand relationship, I am a stronger proponent of multiple FR appreciation. Therefore, I consider 23x P/FFO a more appropriate (and still conservative) scenario. While this alone would not lead to substantial upside, combining it with a dynamically growing DPS (8% CAGR over 2019 – 2023), one could hope for low double-digit total returns at a moderate risk level .

Investment thesis and key takeaways

Even though FR’s share price has seen solid gains over the past couple of months, I think there’s more upside to be had given its valuation relative to its peers. The company offers double-digit growth potential, which I still consider a “buy.”

• income-oriented investors will benefit from dynamically growing dividends
• prudent investors will appreciate the secure funding structure and stability and predictability of FR’s cash flows
• proponents of Benjamin Graham’s margin of safety approach should feel reassured given the valuation gap between FR and some of his peers

FR is one of the top industrial players on my list and one of only two industrial REITs I’m currently invested in. I believe the Company will benefit existing and new shareholders as it has laid the groundwork to capitalize on future positive changes in the market environment (considering both the interest rate environment and the industrial property sector). I am optimistic on FR.