First Industrial Realty Trust (FR 1.46%) is a large warehouse real estate investment trust (REIT). Since hitting a high point in early 2022, investors have pushed shares lower by around 20%. The thing is, this landlord continues to operate at a high level and has pretty much locked in better results for 2023. What were investors thinking?
A victim of strong pandemic performance
First Industrial's stock took off like a rocket following the brief pandemic-related bear market in 2020. The coronavirus led to countries asking citizens to socially distance themselves, which included temporary shutdowns of many non-essential facilities (including many retail outlets) as well as a shift toward working from home. With more people spending more time at home, retailers had to find alternatives, because U.S. consumers still wanted to shop. That alternative was e-commerce.
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Secondarily, shipping delays were making it harder to get products where they needed to go. To deal with this issue, retailers and manufacturers increased production to ensure they wouldn't run out and needed a place to store this excess inventory.
These two trends led to an increase in demand for warehouse space to serve as temporary holding areas for all of the products getting shipped to people's houses. REITs like First Industrial were basically in the perfect position to help companies with the increase in shipping demand and storage. First Industrial is U.S. focused, with a presence in 15 key markets and material coastal exposure.
Wall Street, as is all too common, jumped on this story and pushed the stock price higher. The advance wasn't unique to First Industrial, with just about all of the major warehouse landlords witnessing sharp share price increases.
As pandemic pressures eased and worries about an eventual recession increased, investors began to lose their appetite for such REITs, leading to sizable stock drops across the board. And yet, the actual demand for storage remained high and the operating performance of the REITs didn't change all that much.
Rental growth seems to be locked in
For example, First Industrial's occupancy was a lofty 98.7% at the end of the first quarter. Although that was down from 98.8% at the start of the year, it was still up from 98% a year ago. Frankly, even 98% is an incredibly strong number. High occupancy generally means that a REIT has pricing power with its customers.
First Industrial's pricing power is on display in the rental increases it has been able to negotiate as it renews leases and leases out vacant properties. Rent hikes averaged around 58% in the first quarter. That's such a huge number partly because leases are on the long side and were signed when demand wasn't nearly as strong, leading to material bumps when the leases come to an end.
There's no particular reason to expect this trend to end. In fact, it is far more likely to continue. Specifically, First Industrial has already signed new leases for 63% of its 2023 rollovers. The average rent increase is roughly 56%. That's a huge head start for the company as it looks out over the year. It is currently calling for funds from operations (FFO), which is like earnings for a REIT, to be between $2.35 and $2.45 per share. That's up from the $2.29 to $2.39 range forecast it had offered up at the start of the year, so performance so far has been even better than management expected. Per-share FFO in 2022 was $2.28.
The rollover of older leases to dramatically higher rent rates won't go on forever, of course, but it also isn't a one-year phenomenon. Investors may have turned a little too dour on the warehouse space.
First Industrial is growing in other ways, as well. For example, the REIT fully leased two new buildings in the first quarter, filled out a partially vacant property, leased half of another warehouse subsequent to the quarter's end (with half still vacant), and started development of a new building. So not only has it locked in big rent increases for more than half of its expiring leases in 2023, but it is also building growth from the ground up.
First Industrial is still hitting on all cylinders
Despite the stock price pullback, it is hard to see how First Industrial is letting shareholders down in any way. Yes, the company will eventually see growth slow, but that doesn't mean it will reverse. Investors were likely a bit too smitten with warehouses coming out of the 2020 recession, but if you are a long-term shareholder there doesn't appear to be any reason to worry about First Industrial's business today.
