Why The Triple-Net Lease REIT Sector Remains Strong And Hit 52-Week Highs
In fact, four of American Realty Capital's REIT peers traded at or near 52-week highs on November 4, when National Retail Properties, as well as W.P. Carey reported strong results for the quarter ended September 30, joining Spirit Realty Capital and Realty Income (which reported on November 3 and October 30, respectively).
The Basic Business Model
• Single-tenant triple-net REITs lease critical real estate assets to credit worthy corporate tenants, who then pay for the taxes, insurance and almost all of the facility maintenance in addition to monthly rent.
• The spread between the weighted average cost of capital and the funds generated from the long-term leases is what's used to pay and grow cash available for distribution to shareholders. (Ideally these leases contain some form of regular scheduled bumps in the rent, either fixed in the lease or tied to an index such as the CPI).
• REITs must distribute at least 90 percent of taxable income to shareholders in the form of dividends in return for not being taxed at the corporate level on these earnings.
• Because REITs do not keep retained earnings at the corporate level to invest in growing the business, they must return regularly to capital markets -- both debt and equity -- in order to fund growth.
Great News - A Perfect Storm
The combination of a steadily growing U.S. economy with plenty of low cost debt capital available to fund acquisitions, combined with very modest new commercial real estate construction since the Great Recession, has created an ideal environment for the single-tenant net-lease sector to thrive.
Mr. Market Rewards "Simple" And "Pure Play"
When most investors think about single-tenant landlords, the first thing that usually comes to mind are companies that own convenience stores, drug stores, restaurants and other free-standing retail buildings.
National Retail Properties, in particular, has been a publicly traded REIT since 1984. True to its name, it owns about 2,000 small U.S. properties leased to more than 350 different tenants in 47 states. The company also has a history of raising dividends for 25 consecutive years.
Realty Income, meanwhile, owns more than 4,200 properties in 47 states and Puerto Rico, and is also referred to by many as "The Monthly Dividend Company." Realty Income has paid shareholders more than 530 consecutive monthly dividend payments, which include more than 75 dividend increases since 1994.
Likewise, Spirit Realty Capital owns more than 2,000 sites and is highly concentrated in the U.S. retail sector, with top 10 holdings that include Shopko, Walgreens, 84 Lumber and Circle K.
These are three businesses that clearly meet Warren Buffett's "any idiot" criteria.
ARCP/Cole Capital Looks Complicated
American Realty Capital also owns a large portfolio of more than 4,400 properties that are geographically diverse and leased to a high percentage of investment grade tenants. However, during the past two years, the company grew through a rapid-fire series of transformational acquisitions, which effectively made quarter-over-quarter and year-over-year comparisons meaningless.
When the $11.2 billion Cole Capital merger was added to the mix in February of this year, it introduced a whole other level of complexity:
Is There A Precedent For An ARCP/Cole Capital Combination?
Yes and no. The W.P. Carey business model is similar to the ARCP/Cole combination in several respects. However, W.P. Carey had a four-decade track record of success prior to its recent REIT conversion in 2012.
W.P. Carey underwrites sale-leaseback and build-to-suit real estate assets for both its publicly traded REIT balance sheet and its three non-traded REIT funds. During the third quarter, 90 percent of W.P. Carey revenues came from its public REIT balance sheet and 10 percent came from fee revenue from its $8.3 billion of non-traded fund assets under management (AUM). Additionally, approximately two-thirds of revenues came from U.S.-based assets, and the rest from facilities located in Western and Northern Europe (where W.P. Carey has a 15-year track record of successful investment experience).
REIT Investors Love Dividend Increases
Currently American Realty Capital pays an annual dividend of $1.00 dividend per share. Given recent events, at best it might not be cut, but it certainly won't be raised in the near term. By way of contrast, W.P. Carey has a clear history of paying and raising dividends:
The Realty Income, National Retail Properties and Spirit Realty Capital business models are easy to understand and are thriving in a growing U.S. economy fueled by low interest rates.
W.P. Carey is executing a more sophisticated global strategy, often underwriting unique corporate headquarters, R&D and specialized facilities. It has a more complicated structure, and despite a long history of being investor-friendly, shareholders have not been rewarded year to date with the same total returns as its pure-play peers.
The simpler, better mantra is one of the reasons American Realty Capital cited when it hastily decided to sell its recently-acquired Cole Capital business to RCS Capital less than one year after acquiring it.
Note: article was originally published on November 5, 2014.
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