Playing The Boom In Net-Lease REITs

By Aaron Levitt | September 02, 2014 AAA

For many high yielding assets classes, the Fed’s taper tantrum has sent shockwaves down many investor’s portfolios. Pending higher interest rates has caused widespread losses in a variety of asset class. That includes real estate investment trusts (REITs). REITS and the funds that track them- like the broad iShares US Real Estate (NYE:IYR) –have fallen pretty hard over the last couple of months. That’s in sharp contrast to the past few years as the investors rushed into the bargains and high yields created by the Great Recession.

Well, the recent sell-off could be creating some big REIT bargains again- especially in one specific kind of real estate play. For investors, the triple net REITs have the goods and size to keep up with rising interest rates.

A Focus On Taxes and Other Costs

With commercial real estate and REITs taking a breather in the wake of the Fed’s tapering expectations, the time to perhaps add some exposure could be on. However, given that the next few months may be rocky with regards to higher interest rates, investors may want to look at those REITs with low cost structures.

And you can’t get any lower than the triple-net lease real estate firms.

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, these lease agreements 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. That includes things like rent, plus taxes, insurance and maintenance. At the same time, cash flows for these types of properties are quite dependable because leases are often signed for multiyear terms. 

For the REITs that use these lease structures it can mean extremely low costs of property ownership. Ultimately, that trickles back towards investors in the way of higher and steadily growing dividend payments. Often those payments outpace rises in interest rates and inflation.

So it’s no wonder why investors have flocked to triple-net REITs. Over the past three years, these lease structured REIT's have more than doubled their share of the broad FTSE NAREIT Equity REIT index to 6% - with the last two years experiencing 11% share price growth. More importantly, analysts predict this trend will continue as both retail and institutional investors flock to the REIT type. Adding in huge amounts of triple-net M&A and you have a recipe for long term success. 

Making A NNN Bet

With broad REIT indexes falling around 17% from their highs, the time to strike on some of the higher quality triple-net REITs.

One of the best could be Realty Income (NYSE:O). The firm is a giant among REITs period and owns more than 3,800 different properties leased to such tenants as Walgreens (NYSE:WAG) and FedEx (NYSE:FDX). That size and diversification allows for no single tenant to make up more than 5.1% of O’s revenue. That size also plays another important role- steadily increasing dividends. Realty Income has managed to pay a monthly dividend that has increased for the last 19 years and counting. O currently yields a hefty 5.7%. Not to be outdone, smaller rival National Retail Properties (NYSE:NNN) has had a similar streak of rising payouts and yields 4.9%. 

An interesting growth choice could be American Realty Capital Properties (NASDAQ:ARCP). Since going public in 2011- with just 60 properties- ARCP has undergone a massive transformation. Last year, ARCP bought REIT CapLease for around $2.2 billion. That transaction did wonders for its portfolio size. However, the firm’s biggest news is its pending merger with Cole Real Estate (NASDAQ:COLE). The planned merger will create the largest triple-net leased REIT. ARCP shares yield 7.1%. 

Finally, triple-net-focused W. P. Carey (NYSE:WPC) could be an interesting choice. The reason is unlike O and ARCP, about one-third of WPC’s portfolio is located overseas in Europe. That provides plenty of global diversification muscle for investors. WPC currently yields 5.7%. 

The Bottom Line

With the Fed’s taper tantrum sending many REITs into the basement, the time to buy could be on. And the triple-net players- like Lexington Realty Trust (NYSE:LXP) –could be some of the best bargains. They have the goods to fight rising interest rates due to their low cost structure and high rate of dividend increases.

Dislcosure - At the time of writing, the author did not own shares of any company mentioned in this article.

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