Interview with Ben Butcher, CEO of STAG Industrial

I graduated from business school in 1979 and took a typical MBA job for a couple years. After a couple years, I decided that I really wanted to go into real estate. My maternal grandfather had been an architect developer. I worked for CBRE, my first venture into real estate was as an investment sales broker. I did that for five years in Boston and Washington. I moved on from there to be a developer of supermarket-anchored shopping centers. I moved on from there to be an investment banker at a couple of shops on Wall Street. I left that and started Stag, my current business, in 2003 and sort of proceeded along there. I would say that I've left real estate at least three, maybe four times for things I thought were more intellectually stimulating, but I keep going back to real estate. It's the ultimately pledgeable asset class and therefore an easy place to do larger transactions and to make money.

Stag was a private company from 2003 to 2011. We went public in 2011. Initial equity was $205 million, it's now about $1.7 billion. We will continue to grow. We have an opportunity to grow in what we see as a persisting inefficient market: the single-tenant industrial. So I think Stag, about a little under $3 billion in assets now, total enterprise value, I think we'll over the next five years probably double that. Again, we see lots of opportunity to continue to acquire. We're an external growth company, so we really focus on buying assets. We buy them one at a time, so we have a fairly large organization in order to be able to accomplish that granular buying activity.

In real estate itself, the only thing that really matters is cash flow. Our focus is on producing the most cash flow per dollar of equity invested that we can, with a focus on industrial properties. So we're really agnostic as to location, lease term, tenant credit, a lot of things that other people sort of evolve decision rules around. So our strategy is really to maximize cash flow within the industrial real estate area. We do that by being, we think, a great relative value buyer. In 2015, we initial triage of assets: we looked at about a thousand assets to buy, we underwrote 360 of them, made offers on about 200, and bought 32. That whole progression from a thousand down to 32 was eliminating assets that other people would pay more money for than we thought the asset was worth. So I think Stag will continue to grow because our investment thesis is different, differentiated from the rest of the large industrial buyers. We'll continue to have lots of opportunity to acquire, and again I think we can grow quite a bit.

We identified this persistent market inefficiency, a place where we could buy assets for less than their worth based on their ability to produce cash flow going forward. Surprisingly, that inefficiency has persisted and maybe even gotten better for us. We compete mostly against small buyers, so we're not competing against organized capital. People that we have a significant capital advantage, cost of capital advantage over. The other thing is that the US industrial market is a very large market, a trillion dollars essentially circa value. Half of that is single-tenant, which is what we focus on, so $500 billion. Half of that is our target market. We own about 1% of that market, so there's a very large opportunity for us to continue to do what we do.

Normally, industrial demand or demand for industrial space follows pretty closely with GDP, highly correlated to just GDP growth. Clearly, since the global financial crisis, there has been GDP growth, although muted. So there are three factors that have really promoted industrial demand over and above the demand you might just have from GDP growth. One of them, as you mentioned, is increased manufacturing, the onshoring of manufacturing. Number two, also probably a relatively minor factor, is the shortening and fattening of supply chains. So the Thai floods, the Japanese tsunami, Mexican social unrest caused people to pull in-process inventory back into the US where it would be closer to the lines where it was used. But the most important factor that's producing demand over and above what normal demand would be in industrial real estate is e-commerce. There have been estimates by learned professionals that as much as three times as much warehouse space per dollar of retail sales is required to support e-commerce as it is to support brick-and-mortar sales. That is creating demand not just in buildings that are last-mile delivery buildings, but also broadly across the entire infrastructure of warehouses in the United States, and broadly wherever there's population. So it's not a coastal thing or a New York thing or whatever, it's broadly across the entire United States.

Well, we try to make sure they're happy. One of the beauties about industrial real estate is that the decisions to stay or go are not whimsical. If you're dealing with urban office, the CEO doesn't like the color of the marble in the lobby or he's bought a new house and doesn't like his commute or something like that. Industrial users tend to only leave if there's a valid business reason. So tenant retention tends to run in the 70 to 80% area just as a normal course. So if you're a reasonable customer service, pay attention to keeping the building clean, dry, and being responsive to their needs, unless the building isn't big enough for them, they'll tend to stay. So it is a very good asset class in terms of being able to promote high retention. There is tension, though, in the process. We don't want to lose the tenant. Industrial leases tend to be 3 to 5 years. If you have to replace the tenant, you undergo costs, downtime, etc. So we're going to be anxious to be accommodating in the negotiation. In the same way, the tenant doesn't really want to leave, so they tend to be accommodating in negotiation too. But what it means typically is that you end up achieving slightly lower rents in retention than you would if the building went vacant and you leased it to somebody new. But clearly, it's beneficial to industrial landlords to retain tenants, and we're very conscious of that and pay attention to our tenants and their needs, etc. We have to be open to spending money on the building when the building is not meeting their needs, either by expanding it, providing more dock doors, more power, various things like that.

In 2007, we went to Europe, opened three offices, laid $2 million on the ground, and came back. So I think if we were to look at something now, we'd look at either probably Mexico and possibly Brazil. However, the statistic I mentioned before about the size of the market in the US and our penetration to that market, only about 1% of our target market, we have plenty to do here and quite a long runway to grow here. If we were 5% of our target market or 10% of our target market, we'd be the largest industrial REIT, be bigger than Prologis. So there's a lot of runway here for us in the States.

The greatest challenge for this industrial-focused REIT is getting people to understand that we will produce more cash flow than our competitors per dollar of equity. We are undervalued in almost every metric versus the other REITs. I think the other thing is an appreciation by the public that this e-commerce demand is causing demand to continue to exceed supply. There have been prognosticators, probably the same people who said interest rates are going to go up for the last four years and they keep waiting for them to go up. They've been predicting that demand is going to be outstripped by supply. There are some markets where that's happening, but across the US, it is at best meeting demand, new supply, and clearly demand cannot exceed supply forever. Vacancy can't go to zero or below zero, but there is a very healthy dynamic in the market right now: supply and demand.

Real estate has been called a quintessential catch-22 business: you can only get a job if you have experience. So I would tell people there's lots of opportunity in real estate. The industry continues to transition. The existence of big data and data in relatively free databases allows people who don't have a lot of experience in the industry to be very effective in the industry, which was not the case for a long time. So I think there's a lot of opportunity for people who are sort of cognizant of how to work with spreadsheets and with databases, etc., to make an impression. But because of this catch-22, I would say don't be so worried about where your first job is. I would encourage people, if they have the opportunity to work in brokerage firms where you can get sort of more shallow but more broad experience, to go ahead and do that for a few years. The other thing is, although real estate is less and less a local business, I think it's important that you be cognizant of where you want to live and you want to develop your networks in a particular area. So I think there's a lot of opportunity, and a lot of opportunity for people with new skill sets to replace some of the fuddy-duddies like me.