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Terreno Realty Stands on Solid Ground: Opinion

Terreno's properties are focused on satisfying submarket demand. These properties may be warehouse/distribution, flex (including light industrial and R&D) or trans-shipment (truck terminals), depending on the submarket. To create a margin of investment safety, the company acquires both value-add and stabilized properties at discounts to replacement cost. To minimize risk, it doesn't do ground-up development, purchase raw land or enter complex joint ventures.

Management

Senior managers are veterans of AMB Property, which was acquired by Prologis (PLD). This bodes well for Terreno:
  • W. Blake Baird, chairman and CEO. Prior to co-founding Terreno Realty Corporation, Blake was president and a director of AMB Property and chairman of its investment committee.
  • Michael A. Coke, president and CFO. Before co-founding Terreno Realty Corporation, Mike was CFO at AMB.

Conservative Profile

Terreno has both a conservative operational platform as well as conservative financial policies, which should help ensure that growth in its property portfolio is profitable, sustainable and consistent. Among the policies in place that will help ensure that this REIT performs well for investors (i.e., a balanced risk/return profile) are:
  • Majority independent directors with diverse expertise who serve annual terms. The board does not have staggered terms, which helps avoid blocks of corporate actions.
  • Not structured as an UPREIT. This reduces the complexity of the business model.
  • No ground-up development. This serves to reduce the risk of new development, which can tie up capital and reduce occupancy and funds from operations.
  • No complex joint ventures. This simplifies the portfolio ownership and allows the company and the investors to access properties without dealing with complex partnership agreements.

Likewise, the REIT has conservative financial policies in place to ensure the sustainability of its operations. Among the financial policies are:
  • Limiting the sum of the outstanding principal amount of consolidated indebtedness and the liquidation preference of any outstanding perpetual preferred stock to less than 40% of the total enterprise value;
  • Maintaining a fixed charge coverage ratio in excess of 2.0;
  • Limiting the principal amount of outstanding floating-rate debt to less than 20% of total consolidated indebtedness; and
  • Staggering debt maturities that are aligned to expected average lease terms (five to seven years), positioning Terreno to reprice parts of the capital structure as rental rates change with market conditions.

The conservative financial profile is revealed in the REIT's financial metrics:

Top Tenants

Terreno's top tenants account for 59% of its base rent and include a mix of company sizes:

Although the amount of the base rent is high, investors should expect this in a new and growing REIT. Nonetheless, investors should pay attention going forward to make sure that the exposure begins to recede.

Financial Snapshot

As stated earlier, Terreno is a newer REIT, having done its IPO in February of 2010. As a result, the company's metrics and earnings have not yet been fully established.

The following data (from SNL Financial) show that the dividends being paid on the shares are not fully supported by the funds from operations (FFO) of the company. One of the reasons for this is that the company is paying dividends on the FFO-generating ability of the properties as they stabilize and the FFO becomes normalized.

Equity Profile

The following table compares Terreno's equity data to that of DCT Industrial Trust (DCT), Stag Industrial (STAG) and Prologis:

As the above table shows, Terreno is cheap on some metrics: price-to-book ratio and discount-to-net asset value. But it's expensive on others: AFFO payout and EBITDA/EV. The stock overall appears a little overvalued at the moment, and investors might do well to wait for a pullback.

Preferred Stock Profile

Terreno issued a preferred stock on July 13. The issue is Terreno Realty 7.75% Series A cumulative redeemable preferred. The call date for the preferred stock is July 19, 2017. At the current price of $25.55, the yield is 7.58%.

Bottom Line

Investment in Terreno's common stock, at this juncture, is an investment in both management and the operational/financial philosophy of the company.

Management's track record with AMB Property is enviable, and it has shown a thorough understanding of the markets they serve. The locations of the current portfolio properties are both desirable and have barriers to entry.

Terreno Realty is positioning itself to benefit from continued growth in trade focused areas and should be a beneficiary of increased activity in the coastal trade regions.

The yield on the company's common stock is appropriate for the REIT's risk profile but may not be enough to compensate for execution/stabilization risk of this REIT.

For investors with an income bias, an investment in the preferred stock would be more appropriate. For investors with a longer-term investment horizon, the common stock should have upside in the form of increased dividends (and dividend coverage) and capital appreciation.
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