One of the trends that the COVID-19 pandemic has accelerated is the transition from brick and mortar retail to e-commerce. This has had a mixed effect on Canadian REITs depending on the sector.
There many ways to play that trend, but one of the ways that is still trading at a reasonable price is industrial real estate.
E-commerce retailers and logistics companies need a lot of space in order to fulfill the quickly growing demand.
Dream Industrial REIT (TSE:DIR.UN) is riding the wave of higher demand and is growing along with it
Dream Industrial REIT (TSE:DIR.UN) owns 266 industrial properties in Canada, the United States, and Europe, with almost 27 million square feet of leasable space.
To get an idea about the future, it helps to look back a little bit.
At the start of this year, the REIT owned 209 buildings with under 22 million square feet of space, and only in North America.
The reason it was able to grow so much in one year is because it had such a strong balance sheet. Dream Industrial entered 2020 with debt-to-assets of just 23.7%, compared to most REITs which usually have debt-to-assets of more than 40%.
Dream’s European expansion
Early in the year the REIT announced it was expanding into Europe by purchasing $327 million of assets in Germany and The Netherlands.
Europe provides an attractive industrial market. Europe has a much denser population than Canada or the United States, less industrial real estate per capita, and e-commerce has not taken as much market share there yet.
As e-commerce penetration grows, the limited supply of industrial properties will lead to great returns for the owners of industrial real estate.
And by buying real estate in Europe, Dream Industrial REIT can now borrow money in Europe, cheaply. While interest rates in North America are low, they are even lower in Europe.
Ways Dream Industrial REIT Will Grow
Dream Industrial REIT has more ways to grow than most REITs, which will lead to faster growth.
The company had a low debt balance sheet at the start of the year, which has allowed it to grow a lot this year already.
Despite all the acquisitions it has made, the balance sheet is still very conservative. At the end of the third quarter, debt-to-assets was just 29.6%. Management said they can acquire another $275 million of assets while keeping debt below 40% of assets. Acquiring $275 million worth of properties would grow assets by 9%, and probably grows funds from operations (FFO, a REIT’s earnings) by around 9% as well.
5 year dividend adjusted return for Dream Industrial REIT vs S&P/TSX
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Market Cap: $1.97 billion
Dividend Growth Streak: 0 years
Payout Ratio (Earnings): 99.99%
1 Yr Div Growth Rate: 0%
The demand for good industrial properties will also lead to FFO growth
Since the end of June, Dream Industrial has leased over 1 million square feet of space. Roughly 800,000 square feet were lease renewals, and tenants signed up for rents 12% higher than their old leases. It also signed new leases for 300,000 square feet of space. Those new rents were 20% higher than the old rents for those spaces.
The portfolio has an average remaining lease term of 4.1 years, so Dream Industrial is going to have the opportunity to lease out a lot of space at higher rents in the next few years.
The last lever Dream Industrial can pull to grow is lowering its borrowing costs now that it can borrow money at European rates.
In the third quarter it borrowed $200 million at an interest rate of just 0.9%. By borrowing money in Europe and paying off high interest North American debt, the REIT will lower interest costs and increase FFO.
If its average interest rate drops 1% (currently 3.4%), Dream Industrial’s FFO will grow by over 12%.
Finally, Dream Industrial has opportunities to develop its properties. It has identified 27 properties that it plans to develop or redevelop which would add 2 million square feet of space with development yields over 6%.
Dream Industrial REIT valuation
Even with all of this future growth, Dream Industrial is cheap.
2021 is going to have higher FFO, but the REIT is trading at 16.1x 2019’s FFO. It also trades at roughly a 5.7% cap rate (which measures the REIT’s market cap and debt vs the income of its portfolio).
Blackstone, the world’s largest alternative asset manager, recently purchased several industrial portfolios at cap rates in the low 4%’s. At just a 5% cap rate, Dream Industrial REIT would be worth $15.50 (24% upside from today’s price).
The Bottom Line
Dream Industrial REIT is going to grow a lot in the next few years. It is exposed to possibly the best real estate sector and it will benefit as people shop online more, and it is trading at a low valuation. Another REIT of interest, almost in a niche of its own, Fronsac REIT (TSE:FRO.UN).
As if that isn’t good enough, Dream Industrial REIT pays a 5.6% yield with a low payout ratio. It is a great choice for income and growth.