Net-Lease REITs: High Yielders That Are Hot

by Aaron Levitt | October 9, 2012 7:30 am

With the Federal Reserve vowing to keep its benchmark interest rate under 0.25% through mid-2015, yields on bonds aren’t likely to go much higher — at least in the medium term. That means investors looking for income are going to have to do some real digging.

A variety of nontraditional asset classes, like pipeline master limited partnerships[1] and convertible bonds, are getting the nod from yield-hunters, perhaps none more so than real estate investment trusts[2] (REITs). After feeling the brunt of the Great Recession and housing crisis, commercial real estate and REITs have bounce backed tremendously based on their hard asset status and higher yields.

But as we have seen with the multifamily sector[3], the general and overarching real estate run-up may be finally slowing.

To that end, investors may need to be a bit more selective when choosing a REIT investment[4], and one quirky property type called net lease or triple net lease, which offers yields in the 5% to 8% range, could fit the bill exactly.

Net-leased buildings require little to no management and only minimal oversight on the part of the property owner due to how their leases are structured. At their core, a net lease requires the tenant to pay not just rent but also some or all of the property expenses that normally would be paid by the property owner. A triple net lease is one in which the tenant pay rent, plus taxes, insurance and maintenance (most of the net leases mentioned here are the triple net type).

At the same time, cash flows for these types of properties are quite dependable because leases are often signed for multiyear terms. There’s also little risk associated with class-A net lease properties. Good locations and well-maintained buildings are always in demand.

If a crisis does happen and the tenant goes out of business — an unlikely outcome because firms like McDonald’s (NYSE:MCD[5]) and Walgreen (NYSE:WAG[6]) sign the bulk of single-tenant net leases — the property owner still has a valuable, tangible asset to trade or re-lease. This inspires greater confidence in conservative investors than the recently volatile stock market.

That confidence — not to mention the higher yields — has a variety of private equity funds, pensions and other institutional investors flocking to net lease properties[7]. According to research by Calkain, the past year saw more than $22 billion in transactions involving net lease properties, with retail accounting for approximately $6.9 billion of that.

The deals keep coming in as well. Net lease king Realty Income (NYSE:O[8]) recently announced that it will pay $2.95 billion for American Realty Capital Trust (NASDAQ:ARCT[9]), which owns 501 mostly net lease buildings. Within 24 hours of that deal, Lexington Realty Trust (NYSE:LXP[10]) announced it was acquiring a portfolio of net lease office and industrial properties[11] from its joint venture with private Inland American for $480 million.

Overall, these sorts of mega-transactions indicate just how voracious institutional investors’ appetites are for quality net lease assets. With the U.S. economy still on shaky ground, it’s doubtful that a more attractive investment alternative will emerge anytime soon. Analysts figure that net lease properties will remain in favor for the next three to four years. Given the fact that the Fed is planning on keeping interest rates near zero for the foreseeable future, that prediction will most likely be true.

This is exactly why investors may want to stuff their portfolio full of the triple net players.

That task is surprisingly easy because a number of real estate investment trusts focus on this lease type. Realty Income is the biggest by number of properties, but others, such as Agree Realty (NYSE:ADC[12]) and newly IPO’d Spirit Realty (NYSE:SRC[13]) offer investors access to triple net lease stability.

However, the best in the sector could be National Retail Properties (NYSE:NNN[14]).

Cute ticker aside — “NNN” is the industry moniker for a triple net lease — National Retail is a stalwart of stability in commercial real estate. The REIT owns a diversified portfolio of 1,506 investment properties across 47 states, with total gross leasable area of approximately 17.8 million square feet. More important, these properties are leased to more than 300 tenants in 36 industry classifications. That provides its properties with proper diversification.

Even better, National Retail’s occupancy rate has never dropped below 93.5% in its history. That’s due to strong underwriting and smart selection of tenants.

That strong tenant occupancy coupled with conservative accounting has produced consistently rising funds from operations (FFO) and made this REIT a dividend champion. National Retail is one of only four publicly traded REITs and 104 publicly traded companies in America to have increased dividends for 23 or more consecutive years. That’s pretty impressive, considering real estate’s issues during the Great Recession.

Shares of NNN are up roughly 25% year-to-date, and today, investors can get them with a juicy 5.2% dividend yield. That’s significantly more than a 10-year Treasury and the 3.88% average for all equity REITs.

All in all, National Retail Properties makes an ideal candidate for an income portfolio and for playing triple net lease properties in coming years.

As of this writing Aaron Levitt doesn’t own any securities mentioned here, but he may initiate a long position in NNN within the next 72 hours.

Endnotes:
  1. pipeline master limited partnerships: http://www.investorplace.com/2012/09/time-to-dive-into-downstream-mlps/
  2. real estate investment trusts: http://investorplace.com/2012/09/reits-ready-to-ride-a-successful-stimulus/
  3. multifamily sector: http://www.investorplace.com/2012/09/multifamily-reits-may-have-peaked/
  4. more selective when choosing a REIT investment: http://investorplace.com/2012/08/3-reits-to-buy-now-for-the-dividends/
  5. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  6. WAG: http://studio-5.financialcontent.com/investplace/quote?Symbol=WAG
  7. flocking to net lease properties: http://nreionline.com/finance/investment/net_lease_props_hot_09262012/
  8. O: http://studio-5.financialcontent.com/investplace/quote?Symbol=O
  9. ARCT: http://studio-5.financialcontent.com/investplace/quote?Symbol=ARCT
  10. LXP: http://studio-5.financialcontent.com/investplace/quote?Symbol=LXP
  11. acquiring a portfolio of net lease office and industrial properties: http://nreionline.com/finance/investment/net_lease_props_hot_09262012/
  12. ADC: http://studio-5.financialcontent.com/investplace/quote?Symbol=ADC
  13. SRC: http://studio-5.financialcontent.com/investplace/quote?Symbol=SRC
  14. NNN: http://studio-5.financialcontent.com/investplace/quote?Symbol=NNN

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