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Better Buy: Duke Realty Corp vs. Public Storage

Dec 20, 2020 by Matthew DiLallo
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Duke Realty (NYSE: DRE) and Public Storage (NYSE: PSA) are real estate investment trusts (REITs) focused on owning warehouses. However, there's a key difference between the two. Duke Realty owns large-scale logistics facilities, while Public Storage operates mini-warehouses known as self-storage facilities. That's noteworthy since they lease space to different types of tenants.

Here's a closer look at the case for and against buying these warehouse owners right now.

The case for and against buying Duke Realty

Duke Realty is an industrial REIT focused on logistics properties. It currently owns 526 facilities with 159 million square feet of rentable space in 20 major U.S. logistics markets.

The REIT primarily leases its space to large corporate tenants in the transportation, e-commerce, and manufactured products sectors under long-term contracts. Its largest tenant is e-commerce giant Amazon (NASDAQ: AMZN), at 10% of its total space. These properties are crucial to supporting its tenants' operations. That's a key reason it collected more than 99% of the rent billed during the COVID-19 outbreak.

Instead of hurting its business, the pandemic has created a huge tailwind as it has accelerated the adoption of e-commerce. According to one estimate, the U.S. will need an additional 1 billion square feet of warehouse space by 2025. That has allowed Duke to greenlight several new projects, which leads it to believe it can grow its cash flow and dividend at a high single-digit growth rate over the coming years. Meanwhile, it has a strong investment-grade balance sheet to finance that growth.

The case for and against buying Public Storage

Public Storage is a self-storage REIT. The company owns nearly 2,500 facilities across 38 states with 171 million square feet of rentable space. It also has a 35% interest in Shurgard Self Storage, which owns 239 self-storage facilities in Western Europe, and a 42% stake in PS Business Parks (NYSE: PSB).

The company leases space in its self-storage facilities to more than 1 million customers under short-term contracts. They range from small businesses to retail customers that need permanent and transient storage space. That lease structure and customer type are worth noting as it makes the company's rental income highly sensitive to changes in the economy. That was evident in 2020. The REIT's same-store net operating income fell $22.5 million during the first nine months of the year due to a 0.6% decline in rental income and a 22.5% drop in late charges and administrative fees as it wrote off some fees to help financially strapped customers during the pandemic. In addition to that headwind, the company has also faced significant competition in recent years as developers flooded the market with new self-storage facilities. That has kept a lid on lease rates.

However, one of the benefits of its focus on short-term contracts is that it can quickly raise rates when market conditions improve. In the meantime, the company has ample financial flexibility to weather these storms. It had nearly $300 million in cash at the end of the third quarter and A-rated credit. Because of that, its 3.6%-yielding dividend is on rock-solid ground. Further, it has the financial flexibility to continue expanding its portfolio, which it recently did by purchasing a 36-property portfolio in December for $528 million. Those investments should eventually pay dividends as they should help the REIT grow its FFO and shareholder payout once its current headwinds fade.

Visible growth vs. waiting for the recovery

Public Storage's focus on operating mini-warehouses that it leases to more than a million customers under short-term contracts has its benefits and drawbacks. On the downside, its income is under pressure when there's too much competition and the economy weakens. On the other hand, it has lots of upside in a recovery since it can quickly raise rates.

Contrast that business model with Duke Realty. It operates logistics properties leased under long-term contracts to top-tier tenants. Because of that, there isn't much variability in its income. Meanwhile, it's in a fast-growing sector. Thus, it has visible growth ahead, whereas investors need to wait for the self-storage market to improve before Public Storage benefits. Given that difference, Duke Realty stands out as the better stock to buy.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Matthew DiLallo owns shares of Amazon and Public Storage. The Motley Fool owns shares of and recommends Amazon and recommends the following options: long January 2022 $1920 calls on Amazon and short January 2022 $1940 calls on Amazon. The Motley Fool has a disclosure policy.