The supply chain dislocations that were sparked by the pandemic in 2020 helped set up industrial real estate investment trusts (REITs) like Stag Industrial (STAG 1.27%) for stellar results that year and in the years that followed. The performance surge won't last forever, of course, but so far Stag management is suggesting that 2023 should be another year of growth.
Here's what you need to be watching as the year progresses.
Stag Industrial has assets that are in demand
The industrial warehouse and manufacturing assets that Stag Industrial owns are not particularly exciting. In fact, many are downright boring and even kind of ugly to look at. But they are vital cogs in the machine when it comes to creating and distributing the products people and businesses use every single day. The importance of warehouses and distribution centers, for example, became increasingly apparent during the early days of the coronavirus pandemic, when consumers were socially distancing and ordering more products online because they weren't going to stores.
The ongoing increased need for these properties provided the setup for Stag's 2022 results, which were pretty good. The REIT's funds from operations (FFO) rose roughly 7% year over year in 2022. That might not seem like a huge number, but REITs are dividend-focused investment vehicles that tend to grow fairly slowly over time. On that score, funds available for distribution rose a huge 16%.
The two big stories here are a high occupancy rate and strong pricing power. On the occupancy front, Stag's average occupancy in 2022 was 98.5%, but it ended the year at 99%. Basically, it has virtually all of its properties full, which sets the stage for a strong performance in 2023, even if it loses some tenants. Big demand, meanwhile, supports the REIT's ability to charge higher rents, which is the second key factor. New leases signed in 2022 saw a roughly 30% increase over the rate paid by the prior tenant and renewal leases saw a 20% price bump.
Looking to the future
That was 2022, but what about 2023? The first factor to consider is that all of the leases signed during the year will continue to show benefits in 2023 until they lap the lease signing. So 2022's success will roll over into this year, leaving Stag with a strong foundation for growth.
But the strength Stag witnessed in 2022 hasn't just ended. Demand remains fairly strong for industrial properties. So management expects to see solid leasing activity and leasing rates in 2023, as well. So far the REIT has addressed around 62% of its expiring leases with the average new lease about 30% above the previous one. There's still more leasing work to do, but it would be shocking if the bottom fell out of this market overnight.
However, the average lease in Stag's portfolio is around 4.7 years. Every lease won't be rolling over, which is where contractual rent escalators come in. The company's average escalator is 2.5% or so. So the vast majority of the portfolio will see only a modest boost and will offset the larger rent gains from releasing activity. All in, same-store net operating income is expected to rise between 4.5% and 5%.
A slowdown is inevitable for Stag
Funds from operations are only expected to expand in the low single digits, which might seem like a bit of a letdown, given the strong business backdrop. However, Stag is a REIT focused on reliable and steady growth over time, so this is a reasonable expectation after such a strong showing in 2022. It's also logical to expect the hot industrial sector to cool off and a slow pullback is much better than a sudden drop, which doesn't seem likely unless there is a fairly deep recession.
Investors happy to collect a solid 4.1% dividend yield (the adjusted FFO payout ratio was a modest 66% in 2022), at a time when an S&P 500 index exchange-traded fund yields a scant 1.5% or so, should like what they see here.