Like most of the stock market, the real estate investment trust (REIT) sector took it on the chin in 2020. However, REITs have come back strong, on average, which suggests that last year's downturn was a unique buying opportunity. But is it really too late to buy great real estate stocks? Here's a look at some net lease REITs that you still might find attractive even after the strong recovery.
What's a net lease?
The REIT sector is filled with different and unique property types. Net lease, while in its own space, actually crosses different property niches because it speaks to the way in which a property is operated. Simply put, net leases mean that the lessee is responsible for most of the operating costs of a property. The landlord basically just has to collect the rent, making the difference between its cost of capital and the rents it collects.
This really only works for properties with one tenant, so things like strip malls and multi-tenant office buildings are out. But there are a large number of sectors that are perfect fits, from retail to healthcare. And because net lease REITs generally lock in their costs with long-term financing, it tends to be a very low-risk way to run a portfolio.
Every net lease REIT is different, of course, but on the whole, this is a very attractive segment of the REIT space for conservative, income-oriented investors.
An opportunity gone by
Realty Income (NYSE: O), National Retail Properties (NYSE: NNN), and W.P. Carey (NYSE: WPC) are three of the oldest, best-known names in the net lease space. At the worst of the 2020 market downturn, their yields spiked as high as 9%, in the case of W.P. Carey.
In hindsight, which is 20/20, it was a clear buying opportunity. Since that trough, the stock prices of these three net lease bellwethers have recovered, and the yields have declined.
But that doesn't mean that there's no opportunity here. As noted above, every net lease REIT is different, and you might still find that there's a reason to buy.
Always a bit unloved
For example, W.P. Carey's current yield is around 5.4% today compared to roughly 4% for Realty Income, 4.5% for National Retail, and 2.3% for the average REIT, using Vanguard Real Estate ETF as a proxy. That makes W.P. Carey look pretty attractive, relatively speaking. So it hasn’t been overlooked due to poor performance: It has increased its dividend every year since its 1998 IPO.
The issue is that W.P. Carey is a bit outside the box, with a highly diversified portfolio sector-wise (including industrial, warehouse, office, retail, and self-storage components); material foreign exposure (about 36% of rents); a willingness to work with lower-quality tenants (less than 30% of rents come from investment-grade lessees); and a legacy asset management business that is being slowly shut down.
That said, given the consistent dividend growth, it's hard to question the company’s business approach. Based on current 2021 guidance, nearly 98% of adjusted funds from operations (FFO) this year will come from its core real estate business. In other words, W.P. Carey is getting less complex, is well-run, and looks like it is relatively cheap today if you are willing to think just a bit creatively.
Closing the gap
Next up is National Retail Properties, which was having trouble collecting the rent it was owed early in the pandemic. However, its collection rate was 99% in July. Clearly, the worst appears to be over. And it's worth noting that the REIT increased its dividend in 2020, despite the headwinds, extending its annual streak to more than three decades (after another hike in 2021 the streak is now at 32 years). This is a well-run net lease REIT.
But here's the thing: For the last decade or so, NNN has usually traded in lockstep with industry giant Realty Income, yield-wise. Today, though, National Retail's yield is half a percent higher. That's small on an absolute basis, but in terms of percentage, it's a huge 25% difference.
To be fair, National Retail is still working back from the 2020 hit and is strictly focused on retail assets, so this may not be the best option for all investors, but relatively speaking it still looks like it's trading at a discount to the historical levels investors have afforded it. That discount could close as performance continues to improve.
A change is coming
What about Realty Income? Of this trio, it is the least attractive valuation-wise. In fact, the current yield is on the lower side of its 10-year yield range. It is likely fully priced or possibly a touch expensive. However, with over a quarter-century of annual dividend increases under its belt (like National Retail, it is a Dividend Aristocrat) and a monthly pay dividend, Realty Income is always an investor favorite. So a premium price is the norm here.
In fact, its price to projected 2021 adjusted FFO ratio is a heady 20 times. For reference, W.P. Carey's price to projected 2021 adjusted FFO is around 15.5, while National Retail's number is about 15.8 times.
Before moving on, however, investors should note that Realty Income is buying peer VEREIT (NYSE: VER). This move will make it the largest net lease REIT in a niche where size confers important advantages, including access to low-cost capital and an ability to take on deals that are too big for smaller peers. And the acquisition is expected to be 10% accretive from day one.
Realty Income is a great net lease REIT that's about to get even better. Value investors will probably want to look elsewhere, but conservative income investors that want to own industry leaders might still see some attraction here, given the business boost that's likely to come from the VEREIT purchase.
It's a tough yield environment
To be fair, none of these three net lease REITs is anywhere near as cheap as it was in 2020. But the industry leaders all have something interesting to suggest that there's still value to be had here.
Perpetually overlooked W.P. Carey is always relatively cheap, even though it is increasingly focused on its core portfolio. National Retail still has investors worried despite improving performance, suggesting that a valuation gap still exists. And Realty Income, which always seems to get a premium valuation, has a near-term catalyst that could spur even better performance. With the market yielding a dismal 1.3%, dividend types might still find all three attractive.