The real estate investment trust (REIT) structure is intended to provide individual investors with simplified access to institutional level properties. However, not all REITs are made equal, with some possessing an edge thanks to the types of leases they sign with their tenants. Here's why, if you're looking at REITs, you need to add at least one net lease player to your portfolio.
The big benefit
If you were to rent out an apartment to someone, you would collect a monthly check in exchange for allowing your tenant to occupy your unit. However, your relationship wouldn't stop there. You would need to handle any repairs that came up and, depending on the property, you might end up covering certain utility costs. You would also be on the hook for taxes and regular maintenance, such as yard work. All those extra costs add up and eat into your returns, and that doesn't even consider the time and hassle involved in overseeing the property.
A net lease REIT avoids all of that. Tenants in a net lease scenario are responsible for most of the expenses of the properties they occupy. Although a simplification, the landlord just has to sit back and collect the rent. It's a fairly low-risk way to run a property. In effect, the property owner makes the difference between its financing costs and the rent it earns. It's easy to see why a landlord would want this, and a shareholder, but it's actually a good deal for the lessee, too.
Generally speaking, net lease properties are single tenant and important to the lessee's business. Thus, it wants to make sure they're well maintained. And usually the lessee wants to sign a long-term lease, ensuring it has control of the location for many years. Net leases often come about when a company sells a property it owns to raise cash and instantly leases it back. That cash can be used for growth investments or solidifying a balance sheet, without the need to tap the capital markets. It's something of a win-win deal.
A growing reason to like net lease
So the net lease niche is a pretty good one to look at, but what's really exciting is that more and more property types are falling into the net lease space, making it that much easier to add a net lease play to your portfolio. Historically net lease was focused around retail assets, which is the sector that makes up all of National Retail Properties' (NYSE: NNN) portfolio and around 85% of Realty Income's (NYSE: O) rent roll. Both REITs have decades of annual dividend increases under their belts, qualifying them as Dividend Aristocrats. That is a testament to the net lease model.
But you can get exposure to other property types via net lease as well. For example W.P. Carey (NYSE: WPC) gets roughly half of its rents from warehouses and industrial properties. A mix of retail, office, and self-storage make up the rest. Broadstone Net Lease's (NYSE: BNL) industrial portfolio comes in at around 45% of rents. The rest of its rent roll is from retail, office, and healthcare properties. In some ways these REITs offer one-stop shops if you're looking for diversification.
That said, there are more areas to examine. For example, fast-growing, marijuana-focused Innovative Industrial Properties (NYSE: IIPR) is largely a net lease REIT. So, too, is VICI Properties (NYSE: VICI), which operates in the gaming space. And then there's LTC Properties (NYSE: LTC), which owns senior housing assets.
Some property types don't lend themselves to net lease, like multi-tenant strip malls, but if you're looking at specific property types, it pays to see if there's a net lease REIT in the space. And if there is, give it an extra-close look.
Not perfect, but definitely advantaged
It wouldn't be appropriate to suggest that all net lease REITs are worth owning. There are clearly a range of factors you need to consider before hitting the buy button. However, based on the simple and low-cost nature of a net lease, it's worth the extra time to get to know how you can put some net lease REITs to work for you. That's doubly true today as the use of the net lease approach spreads into an increasing number of property types.