Sunday, July 29, 2007

Reverse Engineering of Warren Buffett’s December 1999 Investment in First Industrial Realty Trust

On December 3, 1999 Warren Buffett auctioned his 20 year-old wallet to benefit charity. Inside was a stock tip. A few weeks later the winner of the auction, John Morgan released the name of the company on the stock tip. It was First Industrial Realty Trust. I am analyzing the company as if it was December 3, 1999. The company was trading at $25 that day giving it a market cap of $941 million.
The Business

First Industrial Realty Trust, Inc. operates as a real estate investment trust (REIT). As of September 30, 1999, the Company owned 950 properties located in 25 states, containing approximately 65.2 million square feet. This makes First Industrial one of the largest industrial property owners in the country. As a REIT the company is not subject to federal income tax, provided it distributes 90% of its taxable income to its shareholders every year.

The Industry

The industrial reit sector has some very interesting characteristics. Industrial properties include distribution centers, warehouses, service centers, light-manufacturing facilities, research and development facilities and small office space for sales and administrative functions. Compared to other reit sectors, industrial reits maintain longer relationships with tenets because of the nature of the properties. Tenets renew leases at a rate greater then 80% and vacancy rates are very low usually around 7%, according to the book Investing in Reits by Ralph Block. The sector is much less prone to overbuilding because most properties are "built to suit" for specific customers and it takes considerably less time to construct and lease an industrial property so there is a much faster reaction time when demand weakens. Because of these factors, the ownership of industrial reits provides for consistent and high returns. Also, because industrial reits are less cyclical then other reits they are relatively recession resistant. Another advantage of industrial reits is unlike office, apartment or retail sectors, this sector has less of a need for ongoing capital expenditures to keep the building in good repair. Despite the interesting characteristics of industrial reits I doubt the reason Buffett bought was necessarily because of these characteristics. I think the reason was mostly because it was just extremely cheap.
The reit industry was doing fine in December 1999 but, share prices continued to fall. Investors ignored reits as they focused on the tech sector even though reits continued to report growing earnings. According to NAREIT, the price of all equity reits from January 1st 1998 to November 30th 1999 fell nearly 40%. Also, as stocks were trading at somewhere around 40 times earnings, reits were trading for only 8 times FFO! Currently reits are trading at 15 times FFO. Reits were yielding 9% at the time and now they yield just 4%.

The Numbers

For the year ended 1998 First Industrial had FFO of $133 million and was trading for $941 million. Giving the company a price to FFO of 7. Also, the company was trading at 88% of book value as of September 30, 1999. The company had a dividend yield of nearly 10%. Two months from now the company will report that for the year ended 1999 the company had FFO of 151 million giving the company a price to FFO of 6! After reading the 1998 annual report and the three 10Qs leading up to December 1999 I can detect no problems the company is going through. First Industrial wasn’t the only reit that Buffett invested in at the time. MGI Properties, Tanger Factory Outlet, Town and Country Trust, Baker Fentress & Co., Aegis realty, JDN Realty, PMC Capital, HRPT Properties Trust, Burnham Pacific Properties and Laser Mortgage Management all were held in Buffett’s personal portfolio around 1999. I will probably research some of these companies at some time in the future.

How it turned out

Buffett said at the 2004 Berkshire annual meeting that he sold off all his reit investments. So, I’ll assume he sold First Industrial at around the same time. He ended up doubling his money in 4 years. This proves that those with their eyes open can still find undervalued stocks in today’s market.