Agree Realty (NYSE: ADC) is a real estate investment trust (REIT) focused on retail properties. That seems troubling at first glance, given the headwinds facing the sector. Retailers are battling the accelerating adoption of e-commerce. On top of that, the pandemic has battered the industry in the past year.
Here's a closer look at whether Agree Realty's focus on owning properties leased to retailers spells trouble for its investors.
Not all retailers are the same
We tend to lump all retail in the same category. Because of that, we assume that the headwinds facing one type of retailer will impact them all.
However, that couldn't be further from the truth. Some segments of the retail market are in a better position to withstand the sector's current headwinds. For example, retailers that sell essential goods like groceries and pharmaceuticals tend to deliver steady sales, even during an economic downturn. Meanwhile, other retail segments are more resistant to disruption from e-commerce. These include home improvement, auto service, off-price retail, convenience stores, dollar stores, and grocery stores.
Because of that, not all retail REITs are in trouble. Some, like Agree Realty, focus on segments of the retail industry less susceptible to its overall headwinds. In its case, it leases the bulk of its properties to tenants in the following sectors: grocery, home improvement, auto parts and services, convenience stores, dollar stores, and pharmacies.
This focus on resilient tenants has paid off during the pandemic. Over the last 12 months, Agree Realty has received at least 99% of the rent payments it has billed.
Further reducing its risk profile
Agree Realty does a few other things that help reduce its retail-focused portfolio's risk profile. First, it focuses on owning properties leased to high-quality tenants. Most of its tenants have strong financial profiles. That gives them the financial flexibility to keep paying rent when times get tough. Overall, 68% of its annual base rent (ABR) comes from retailers with investment-grade credit ratings, while half of the remaining ones are financially strong private companies. In addition, most of its tenants are well-known national or regional brands. Overall, it focuses on financially strong industry leaders operating in e-commerce resistant sectors.
Agree Realty also focuses on freestanding retail properties secured with triple net leases. This lease structure makes the tenant responsible for real estate taxes, maintenance, and building insurance. These leases push more of a building's operating expenses to the tenant, reducing Agree Realty's cash flow volatility.
Another lease structure Agree Realty utilizes is ground leases. Under these leases, which are also triple net, Agree Realty owns the land underneath a retail property. Ground leases are low risk since a tenant could lose their building if they miss rental payments. Overall, 12.7% of Agree Realty's ABR comes from ground leases, with 90% of these tenants having investment-grade credit ratings.
Ground leases generate bond-like cash flow from investment-grade entities at much higher yields than corporate bonds. On top of that, they feature embedded rent growth of around 1% per year.
No trouble at all
While Agree Realty focuses on the retail sector, it's not in trouble. That's because it concentrates on owning properties triple net leased to high-quality retailers in e-commerce resistant sectors. Because of that strategy, Agree Realty has been able to keep growing its dividend during a time when other retail REITs have had to reduce their payouts due to the headwinds facing their tenants.