STAG Industrial Keeps Growing, but How Far Can It Expand?

STAG facility in Missouri. Source: STAG Financial.

Coming into Thursday's earnings release, real-estate investment trust STAG Industrial (STAG 1.60%) had earned a reputation for providing both ample dividends and a good track record of share-price gains to its long-term investors. Even though STAG's third-quarter results were largely in line with what investors had expected from the company, the question shareholders still have is whether STAG will be able to grow fast enough to keep producing the impressive returns that some investors have started taking for granted. Let's take a closer look at how STAG Industrial did last quarter.

The highlights from STAG's third quarter
For the most part, attention centered on STAG's revenue and operational metrics, as investors had already gotten a report on STAG's acquisition activity for the quarter. STAG saw overall revenue climb 22% from the year-ago quarter, with better than 20% gains both in rental income and in tenant recoveries. Expenses grew at an even faster 30% rate, though, crimping GAAP net income.

But in evaluating REITs, most investors prefer to look at operating measures like core funds from operations. The reason is simple: real-estate investments always carry considerable non-cash items like depreciation, and so looking at funds from operations gives a better sense of what actual cash flow looks like for STAG.

On that score, STAG posted solid growth of 20%; but most of the gains were attributable to acquisitions, and an increase in shares outstanding limited per-share gains in core funds from operations to a single penny, at $0.36 per share. That was $0.01 less than most investors had expected to see from STAG.

Michigan warehouse-distribution center. Source: STAG Financial.

Looking more closely at some of the details of STAG's results, occupancy rates for the REIT's portfolio reached 94.8%, which was up from 94% a year ago. Interestingly, though, comparing occupancy rates for comparable properties showed a slight decline, from 92.9% to 92.6%, indicating that the acquisitions that STAG has made in the last year have actually improved its overall operating performance.

Most of STAG's other measures stayed relatively stable even as the number of properties rose. Typical building characteristics were similar, although STAG's average lease size rose by 8% over the past year. Tenant quality has also stayed relatively constant, with slight drops in top-tenant and top-10 tenant percentages, but gains in tenants with more than $100 million in revenue.

What's next for STAG?

By some measures, STAG looks to have a promising future. As of Oct. 30, STAG had a pipeline of potential acquisitions that included 112 industrial buildings worth more than $1.4 billion. STAG's pipeline includes not only properties that have gotten through its initial screening process, but also transactions that are further along toward completion with contractors or letters of intent. Given the rate at which STAG has closed deals in the first nine months of 2014, a 112-building backlog could give the REIT more than two-and-a-half years' worth of future growth.

STAG is certainly committed to its ongoing acquisition binge. The company said that in 2015, it will target new acquisitions of industrial buildings worth in the aggregate 25% of STAG's net real-estate portfolio value as of the end of 2014.

North Carolina-based property. Source: STAG Financial.

At the same time, though, STAG has worked hard to get properties leased, and its efforts have been largely successful. Even after the quarter ended, STAG has gotten four leases executed in October. It's currently in negotiations on nearly a dozen more that would cover about 1.2 million square feet if completed.

The key to STAG's future is whether its financing activity continues to generate the capital it needs to expand. Currently, STAG boasts an investment-grade rating, and it has also made successive offerings of equity to investors hungry for high dividend yields. As long as the industry is healthy, then the doors should remain open to capital markets that can finance its expansion. If credit tightens, though, then STAG could face obstacles to keeping up its growth rates.

Overall, STAG Financial's results supported the REIT's long-term strategy toward expansion and profit growth. As long as conditions are favorable in commercial real estate, then STAG should be able to keep executing on that strategy to shareholders' benefit. Long-term investors need to be mindful, though, of the potential for changing conditions to become less favorable for STAG at some point in the future.