Let the good times roll

A threefold increase in market value results in quixotic expectations

July 14, 2016

About the author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Between 2010 and 2020, Ganel worked for Silvergate as Vice President in Capital Markets. He provides advisory services to family offices,  private companies, and financial advisors.

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DCT industrial trust (NYSE:DCT) acquires, develops, leases and manages industrial properties. As of the fourth quarter of 2015, the industrial REIT owned 394 operating properties leased to about 900 customers with an average size of 158,000 square feet for a total of 62.2 million square feet. The non-operating properties include 8 redevelopment projects, with a total of 900,000 square feet, and 5 construction projects. More importantly, the company market value increased by threefold in the past four years, a 25 percent annual return.

In 2011, revenue was $231 million and Net Operating Income was $166 million. The company owned 409 buildings with a total of 58 million square feet. The industrial properties market value was $2.8 billion (a 6 percent capitalization rate), with an overall vacancy of 90 percent. Its 247 million outstanding shares traded between $3.88 and $5.89.

“Fundamentals for industrial real estate continue to modestly improve,” wrote DCT management in 2011. “We expect moderate economic growth to continue through 2012, which should result in continued positive demand for warehouse space as companies expand their distribution and production platforms.” But neither “modest” nor “moderate” accurately describe the next four years.  

Fast-forward to the end of 2015 and DCT had a stellar track record. Revenue was $353 million, an increase of 50 percent and Net Operating Income was $261 million, an increase of 57 percent. The company owned fewer buildings, but asset base increased to $3.6 billion with an overall vacancy of 94.4 percent. After a one-for-four reverse stock split, DCT outstanding shares were 88 million and traded between $31.08 to $38.82.   

describing the change in the portfolio size compared to revenue
Source: Company 10-K reports 

NOI is a key component in the valuation of commercial real estate, notes Trevor Calton of Urban Asset Advisors, a real estate firm. And DCT focused on increasing NOI. The company increased occupancy by 5.2 million square feet. It increased average base rent to $5.56 from $3.97. And the market, quite justifiably, awarded the company with a higher market value. But the unusual four-year increase in market value should now deter investors, not attract them. 

There are two reasons for a halt in action. First, an exorbitant share price. In 2011, a share had cost 7 times the NOI per share. The multiple is now 12 times with a share price of $36 and $2.96 NOI per share. Second, NOI per share will need to be $5.18 in four years to meet a 15 percent return. It is a Herculean task. While the stellar performance of 2011 to 2015 should be a case study at business school, similar to a student upon graduation, it is time to sober up.

Describing the change in price of share compared to net operating income for DCT industrial trust
Source: Company 10-K reports