Not Following an Industrial REIT's Insiders

 | Jul 23, 2013 | 11:00 AM EDT
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Several company insiders at Terreno Realty (TRNO) have been directly purchasing shares of the company's stock since the beginning of July. Terreno is a real estate investment trust focused on investing in warehouse, distribution and related buildings. Terreno has a market capitalization of about $370 million. On average, about 100,000 shares of the stock are traded per day, so at a current price of over $19, there is nearly $2 million in daily dollar volume.

The company's properties are primarily near major metropolitan centers, including Los Angeles, New York and San Francisco.

We track insider purchases, because studies generally show at least a small outperformance effect for stocks bought by insiders, particularly stocks bought by multiple insiders, so it is a good idea to review these names on a case-by-case basis.

One advantage of real estate investment trusts is that they receive favorable tax status from the IRS, conditional on distributing a large share of taxable income to shareholders. Terreno recently increased its quarterly dividend payment to $0.13 per share, which at current prices makes for an annual yield of 2.8%. That isn't a particularly high yield for a REIT, though we suppose that the company could continue to increase its dividends in the future -- the current dividend is up from $0.10 per share two years ago, shortly after Terreno became publicly traded.

Of course, potential income investors should be concerned about how sensitive Terreno or any other REIT might be to a downturn in the economy or in the real estate market; many REITs suspended or cut their dividends during the financial crisis.

Earnings are not a particularly useful metric for real estate investment trusts, as real estate is such a large share of their assets. Under financial reporting requirements, owners of real estate are required to depreciate these assets over time and treat depreciation as an expense. However, unlike other fixed assets such as equipment and vehicles, real estate does not necessarily lose value over time and may even increase in value. As a result, when evaluating the financial performance of REITs, we like to focus on funds from operations (FFO). In the first quarter of 2013 Terreno recorded $2.6 million in funds from operations, a large percentage increase from a year earlier. This came out to $0.16 of FFO per share. If we annualize it (in other words, if we assume no further growth in FFO over the rest of this year), we get a P/FFO multiple of 30.

DCT Industrial Trust (DST) is a larger company (market cap of $2.3 billion) that operates in a similar business to Terreno. Its dividend yield is 3.6%, though we'd note that its quarterly payments have not been increasing and are still less than half of what they were in mid-2008 (this also serves as a warning to potential Terreno investors). DCT's most recent 10-Q shows funds from operations up 15% from the first quarter of 2012, though the diluted share count increased by 11%, and so FFO per share didn't change by as much. Annualizing its reported FFO per share yields a P/FFO multiple of 17. Terreno growing its funds from operations faster a somewhat higher multiple on that basis does make some sense, though of course this is a crude estimate based on limited results.

DCT's history signals that although Terreno could increase its dividend, payments could also fall as a result of poor economic times. In addition, although Terreno has been increasing its funds from operations recently, the P/FFO multiple seems to already include a good deal of future FFO growth. While the consensus insider purchases here are interesting, we aren't particularly excited about it as a stock pick, either generally or as an income pick.

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