Net Lease Assets Buoy Real Estate Investors
The pandemic has turned the commercial real estate world on its head. In the case of large trophy systems such as condominiums and office towers, the interest of investors and thus the value has fallen. At the same time, some of the smallest assets in its heaviest hitters. While practically every commercial sector suffers, STNL (Single Tenant Net Net Leases) have the strongest fundamentals in years. Much of what we consider essential retail today happens in these often discrete storefronts, making net lease REITs unexpected dividend leaders.
Triple net leases for single tenants have been labeled “America’s Real Estate”. With a triple net lease (often referred to as NNN), the renter agrees to pay the rent and all other related costs such as taxes, insurance, and maintenance. The deals tend to offer lower rents as the renter takes on most of the financial burden, but this type of property is considered to be one of the most passive types of commercial property ownership. All over the country, petrol stations, pharmacies, cafes, grocery stores and drive thrus are usually structured as a triple network.
It’s not just retail. Ecommerce distribution centers, while less visible, typically operate as triple net leases and can be some of the most lucrative. Each offers a low-risk, stable income. In the turbulent real estate market ravaged by a pandemic, stable, low-risk income sounds pretty good to investors.
Nine of the 52 equity REITs that paid higher total dividends in 2020 than in 2019 were net lease REITs, the highest sum among any real estate sector. The NETLease Corporate Real Estate ETF, a fund specializing in net rental contracts, was the fifth best fund in the Morningstar Real Estate ETF category in 2020 according to Seeking Alpha. The fund tracks the Fundamental Income Net Lease Real Estate Index, which in turn tracks the performance of the Net Lease Real Estate sector. The index shows that REITs with net leasing have achieved an average annual return of 12.1 percent since the beginning of 2010, outperforming the top-class NAREIT index, which tracks practically every form of REIT. Net leasing REITs have the fourth highest dividend growth rates after cannabis, cell towers, and single-family home rental REITs.
Net rental assets did so well because it is full of important companies. We are now all familiar with life during the pandemic. You still need to do grocery shopping, get your car repaired, fill out prescriptions, fill up with gas, and pick up items from the grocery store. All retail takes place in triple net rental locations. After the initial bans were lifted, the net rental rent collection quickly recovered and was now around 96 percent. It exceeded multi-tenant retail rents by nearly 20 percent. The problem is, there just aren’t enough essential triple net traits to go around.
Safe, passive income from real estate that doesn’t require much attention is exactly what investors want in uncertain times, leading to immense demand for triple net real estate. Political uncertainty surrounding infamous IRS 1031 exchanges, a favorite in the net rental world, added even more demand as stakeholders rushed to close deals while they could. Given the limited supply of triple net leases through 2020 and the weak outlook for retailers, the ardent demand created a market imbalance into which owners were surprisingly willing to sell.
“The sellers who had major retailers like convenience and grocery stores, auto parts and dollar stores saw the cap rate compress,” Anthony Pucciarello, executive vice president of Secure Net Lease in Dallas, told the mall Business Magazine. Pucciarello’s company sold $ 60 million in QuikTrip convenience store properties in 2020. “We couldn’t keep a Jiffy Lube, 7-Eleven, QuikTrip or Dollar General on the market for more than a week.”
Unlike other forms of property, most triple net lease owners aren’t desperate. Wealth is not at risk, income is good, and the investment requires little attention. The prices have not gone crazy either, real estate is being traded at or slightly above the asking price. There seems to be little reason to sell, but a seller’s market attracts many and drives an asset class that investors cannot get enough of.
For investors, the bodega on the street has become a blue-chip investment that generates steady, predictable cash flow over long leases that can survive or even thrive during a pandemic. The long-term outlook for triple net worth looks good too. Triple Net Properties are not only resilient to lockdowns, but also resilient to e-commerce. Essential retail cannot be replaced by Amazon, but there is (yet) no way to deliver fresh tacos from an Amazon fulfillment center.
Mind you, these investments are not without risks. A tenant means vacancies essentially wipe out the property’s cash flow. However, when you look at the property type overall, the rewards so far have outweighed the risk. “The net rental property of single tenants is at the intersection of Main Street and Wall Street,” said Mark West, senior managing director of Capital Markets, JLL. “For the most part, investors get a hard asset and long-term, persistent cash flow. Net lease properties usually offer a very good risk-adjusted return compared to a bond. “
Barring significant changes to 1031 exchanges, the triple net lease sector appears to remain strong through 2021. Lots of capital and solid fundamentals will keep both buyers and sellers active, and will further boost net leasing REITs and other investors specializing in the sector. A vaccine-assisted recovery could put triple net tenants back into expansion mode and offset the imbalance between supply and demand. A recovering economy and a return to the office could mean other real estate investment sectors are getting back in shape and taking the investor spotlight back. However, if for some reason we experience higher volatility, investors may want to double the properties with the most reliable cash flow, and many of them have triple net leases.