Adjusting its business plan to market conditions, Pure Industrial Real Estate Trust has continued to thrive.
by: Ron Engeldinger
When conditions in the marketplace change, successful enterprises make adjustments. Pure Industrial Real Estate Trust (PIRET) is an outstanding example of an organization effectively adapting to changing circumstances. While not abandoning its original goals, PIRET was able to make focused alterations to its operating strategy in response to external conditions. In the end, the company has transformed itself and its operations, and is now even stronger and well-positioned for the future.
For more than five years, a well-managed yet aggressive, investment strategy paid off as PIRET grew to become one of Canada’s largest public industrial real estate investment trusts (REITs). Internally managed, PIRET was launched in 2007 and was one of only a couple of Canadian REITs focused solely on industrial properties. The industrial property niche proved to be profitable.
The Taper Tantrum
By 2013, the company was in a high-growth mode, and investor sentiment was positive. Unit prices were trading above the net asset value (NAV). Since then, however, conditions in the marketplace have changed, and PIRET has successfully modified its strategy accordingly.
Kevan Gorrie, PIRET’s president and CEO, points out that the “taper tantrum”—which refers to the surge in U.S. Treasury yields—in the summer of 2013 had a strong, negative effect on REITs. Interest rate uncertainty hammered share prices. Economists and investors tried to understand the effects of the U.S. Federal Reserve’s decision to wind down its asset purchase program, known as quantitative easing. There was widespread fear of dramatic interest rate increases.
REITs are perceived to be particularly sensitive to rising interest rates, and publicly traded Canadian REITs suffered. The market capitalization of some dropped by as much as 25–30 percent. Gorrie reveals that, as a result, “the capital markets became much more difficult, and the cost of capital rose dramatically. This made it much harder to grow.” PIRET’s goal was to continue its growth, but market circumstances took away much of its ability to issue equity. It had to make changes in the way it acquired property.
PIRET management’s response to the difficult environment has been to undertake a transformation in its game plan. While not abandoning its acquisition goals completely, it focused on becoming more well-rounded in its approach. The company continued to follow the acquisition strategy of purchasing properties in good physical shape with strong tenants. In 2013, PIRET had approximately 8 million square feet under management, and that has grown to about 17.5 million square feet today as the acquisitions continued.
However, the company has become more diversified, developing strengths and expertise beyond the acquisition and management of properties. Gorrie says, “PIRET evolved from a simple real estate aggregator to an asset manager, operator and developer. This was always our plan, but we had to implement the strategy much more quickly.” This evolution has resulted in a more diversified company that can continue to thrive even during unfavourable market conditions.
A New Game Plan
PIRET’s strategy to become a value-added investor in real estate consisted of four components. It began strengthening its balance sheet. It explored development opportunities to complement its acquisition goals. It focused on establishing venture relationships with strong partners, and it undertook a capital recycling program to improve the quality of its cash flow. The company focused on adding high-quality property and high-quality tenants while liquidating some lesser-performing assets at a profit.
Gorrie acknowledges that “fear of interest rate increases has changed the way we look at debt.” In 2014, PIRET began to strengthen its balance sheet by deleveraging. PIRET intends to maintain overall leverage within a range of 45 to 50 percent with a long-term goal of reducing it to 40 percent. This deleveraging has positioned the company to accomplish several lucrative real estate transactions without the need to issue new equity. “We are taking a measured approach to deleveraging and we plan to stick to that approach,” he explains. At the same time, PIRET has continued to enhance unit holders’ value through appropriate stock buybacks. This enables it to continue to make strategic investments.
The strengthened balance sheet has been instrumental in attracting new venture partners. In October 2015, PIRET announced the acquisition of a three-asset portfolio in partnership with Fiera Properties. The properties, located in Alberta and Manitoba, are occupied by stable tenants with long-term lease commitments. In the press release announcement, Gorrie commented that “this is the first transaction of what we expect to be a long and growing partnership.”
Moving into the U.S.
Also in 2014, PIRET moved into the U.S. market by acquiring 10 FedEx sorting and distribution facilities. The online shopping boom in recent years has driven strong demand for warehouse and distribution space. As a leader in logistics management and global transportation, FedEx is well-positioned to capitalize on the e-commerce trend. As Gorrie contends, “This was a key positive development for us. It took us to a different level with a leading global e-commerce service provider.” Currently, PIRET has 13 properties totaling more than 3 million square feet in the U.S. and comprising approximately 22 percent of PIRET’s net operating income (NOI).
The advantages of expanding into the U.S. are a stronger diversification of PIRET’s portfolio and the ability to work with some very creditworthy, stable tenants. There are drawbacks, however, as tax and currency exchange matters can be unfavorable. Gorrie shared that the company plans to keep U.S. investments at around 20 to 25 percent of the overall portfolio.
Adding Value Through Development
Gorrie reveals that development has become a very important component of PIRET’s strategy. The organization wants to continually add value to its properties beyond the underlying value of the real estate. Enhancing the value of the properties is important for creating a good product for PIRET’s investors.
An excellent example of executing a value-added strategy is the project under way in Vaughan, Ontario. In partnership with Scannell Properties, PIRET acquired 60 acres of development land for the construction of a modern FedEx sorting and distribution facility that will serve the Greater Toronto area. At a cost of more than $100 million, this is one of the largest industrial development undertakings in Canadian history. “We are developing some of the best products in the country with a company that is at the leading edge of e-commerce and distribution,” explains Gorrie.
The strategic changes that PIRET has made since 2013 continue to pay off. In 2015, oil price declines weighed down all sectors of the Canadian market, and the industrial REIT market is no exception. Gorrie commented that PIRET plans to hold the course. “We invested about $250 million in 2015, and we expect to be a bit below that figure in 2016. We are OK with that.” With its value-added approach, PIRET can continue to grow through suitable acquisitions, increased development and capital recycling when appropriate. It expects this approach to continue to strengthen the balance sheet and grow cash distributions to the unit holders.
According to Gorrie, “What drives our decision making is simple. Will this improve the business? This is a simple business, and we don’t want to mess it up.” Guided by this philosophy, he adds, “The company has grown up and become more well-rounded.”
As for the future, Gorrie is optimistic. PIRET has continued to flourish in spite of fluctuating market conditions. He maintains, “We are very confident about the future. The industrial real estate fundamentals in Canada and the U.S. are strong. The developments that we have under way will positively and significantly affect the future of the organization.”
This article appears in Colliers International's Winter 2016 edition of Knowledge Leader Magazine.