Duke Realty (NYSE: DRE ) has transformed itself into a promising commercial REIT with significant exposure to the industrial segment over the last five years.
While in 2009 the share of net operating income (NOI) attributable to the industrial segment only accounted for 36%, a series of transactions caused Duke Realty to gravitate toward higher industrial real estate exposure. The segment accounted for 60% of the company's total NOI at the end of 2013.
This focus on industrial real estate should serve Duke Realty well over the next couple of years and materially boosts its cash flow.
In addition to industrial real estate, Duke Realty invests in office and medical office properties. These accounted for 25% and 15% of company NOI at the end of 2013 respectively.
Prologis, Inc., a leader in the industrial REIT space, has a grip on 241 million square feet of industrial real estate, whereas Duke Realty's industrial real estate portfolio consists of approximately 116 million square feet.
Though Prologis is about twice the size of Duke Realty in terms of industrial exposure, Duke Realty is not necessarily a second class player. Its industrial real estate portfolio has a relatively young average building age of only 12 years as compared to 20 years for Prologis. It has occupancy rates above 90% across all building sizes.
Focus on growth regions
A key value determinant for REITs is their geographic diversification in order to mitigate concentration risk.
Over the last four years, Duke Realty has consistently worked at establishing a presence in previously underserved key growth markets such as California, Pennsylvania, New Jersey, and South Florida. It also increased its industrial real estate footprint in Houston, Chicago, and Seattle, among others.
Going forward, Duke Realty's shift toward high-growth markets and industrial hubs with strong economic growth prospect should serve the REIT's cash flow and distribution development well.
Industrial exposure driving rent growth
The industrial real estate asset class should be doing relatively well when the economy does well. With a focus on the industrial segment, Duke Realty should be able to capitalize on strong, cyclical demand for commercial properties.
This cyclical demand should be reflected in improved occupancy rates and strong rent growth going forward.
The chart on the left indicates that rent growth has already bounced back materially from the disaster rates in 2010 and 2011.
In 2013, portfolio rent growth based on renewal leases stood at 3.1%, with the industrial segment outperforming at 4.3%. Duke Realty expects 2014 to see even stronger rent growth.
With industrial rent growth to hit 8.3% in the current fiscal year, it becomes evident that Duke Realty's strategic shift toward industrial properties was the right move. It should pay off handsomely for investors in 2014 and beyond.
Cash flow growth driven by industrial exposure
High expected growth rates for the industrial segment should also leave their mark on Duke Realty's prospective cash flows.
The company's cash flows have already received a boost since 2010.
Its adjusted funds from operations, or AFFO, stood at just $0.76 per share in 2010 and increased by more than 18% until 2013. This is a respectable achievement considering that U.S. real estate has not necessarily been a preferred asset class lately.
With an estimated 2014 AFFO of $0.94, Duke Realty currently trades at approximately 19 times adjusted funds from operations. This isn't cheap, but it appears to be a reasonable multiple given Duke Realty's cyclically positioned real estate portfolio.
The Foolish Bottom Line
With further projected AFFO growth ahead, Duke Realty makes a compelling value proposition that is largely driven by two themes: a recovery in the U.S. economy, and a strategic portfolio repositioning with a higher reliance on business-cycle-sensitive industrial real estate.
Meanwhile, investors get to enjoy a 3.8% dividend yield and regular cash distributions on a quarterly basis.
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