My wife and I bicker about real estate…
She wants to buy a house in New York City to earn rental income. I’m afraid to own just a single property for that purpose… If the tenant can’t (or won’t) pay rent, we’d be in trouble.
This is especially worrisome in New York, where we live…
Because of the political climate here, it took way too much time, pain, and money to evict a recalcitrant tenant even before the COVID-19 pandemic. Now, it’s much worse…
The eviction moratorium in New York was extended again – this time until January 15. And I wouldn’t bet my retirement savings on that being the final extension, either.
My argument to my wife is simple… It’s old hat for equity investors to avoid having all their eggs in one basket. Landlords need to do likewise.
This is true for both individual landlords and professionals…
It even applies to the biggest professionals in this space – like real estate investment trusts (REITs). Tenant concentration – too much rent coming from one or just a few tenants – is a frequently cited risk of REITs.
That has been the traditional knock on Industrial Logistics Properties Trust (ILPT), for example…
Given the growth of e-commerce – which only accelerated during the pandemic – industrial properties like warehouses and distribution facilities tend to attract the “bulls.” It helps that Industrial Logistics’ biggest tenant is e-commerce juggernaut Amazon (AMZN), too.
But when a whopping 49% of rent comes from properties in Hawaii – as is the case with Industrial Logistics – you need to consider spreading out your eggs in different baskets…
Industrial Logistics’ pending acquisition of Monmouth Real Estate Investment (MNR) will change that. Assuming at least two-thirds of Monmouth’s shareholders approve the deal, it should close before the middle of next year.
Monmouth is more geographically diverse than Industrial Logistics… It operates 123 buildings in 32 states. But it still isn’t as diverse as we might prefer… Like Industrial Logistics, this REIT is concentrated on a few customers. Its biggest tenant is FedEx (FDX).
So the post-merger company will still come with some risk. If it didn’t, the REIT’s yield would be closer to 3%. But as always, it pays to do a little research…
Before the merger was announced on November 5, Industrial Logistics’ yield was 4.7%. Its yield jumped to the current 5.7% because shares fell as much as 23% in the weeks after the merger announcement. That type of reaction often happens to companies’ stocks after they announce plans to acquire another firm… Folks just don’t care to crunch the numbers.
As is often the case, this merger will require new debt. But the proper question isn’t just about capital cost… It’s about whether new income will exceed new capital costs. Management expects the deal to be “accretive” – in other words, it says “yes.”
Moreover, I expect the combination to reduce overall business risk…
The new combined REIT will get nearly 30% of its rental income from FedEx (around 21%) and Amazon (9%). The next biggest tenant would be Restoration Hardware (roughly 2%). The top 10 tenants would account for nearly 42% of its rental income.
So while customer concentration could remain a concern, I believe the risk is a lot more palatable because the combined REIT will involve much more than just Hawaii and Amazon. That’s especially true since the company’s yield is still greater than 5% today.
Even better, the portion of the combined REIT’s rent coming from investment-grade tenants would rise from 71% to 77%. The occupancy rate would edge up from 99% to 99.3%. And the weighted average remaining lease term will increase from nine years to 9.2 years.
In short, the combined REIT will be a much better business than investors currently believe.
Industrial Logistics looks to be a classic “prudent yield hog” stock… The REIT’s yield is high, but not too high to signal market concern about the sustainability of its dividend.
It’s worth considering today.
Good investing,
Marc Gerstein
