Net lease REITs have become an increasingly popular way for investors to gain exposure to single-tenant real estate.
This post will guide you through all you need to know about net lease REITs in relation to single-tenant properties.
Let’s skip the small talk and get right to it!
What are Net Lease REITs?
Net lease REITs are real estate investment trusts (REITs) that own freestanding properties leased to single tenants under long-term net leases.
The tenant is responsible for costs like property taxes, insurance, and maintenance – the “triple net”.
The landlord receives a steady rental income with minimal expenses.
Properties are leased to high-quality tenants like national retail chains, restaurants, and corporate offices under 10-25-year leases.
If the tenant defaults, the landlord can replace them more easily given the specialized property’s single-use design.
Net lease REITs provide stable growing dividends along with diversification for investors’ portfolios.
They are less sensitive to broader real estate market fluctuations.
Investors get exposure to investment-grade rated tenants without having to directly manage properties.
Net lease REITs own portfolios of hundreds or even thousands of properties, providing geographic and tenant diversification.
They finance acquisitions conservatively to protect dividends during recessions.
Types of Net Leases
There are three primary types of net leases used in single-tenant REIT properties:
Double Net Lease (NN) – Tenant pays base rent plus property taxes and insurance costs. The landlord covers structural repairs and maintenance.
Triple Net Lease (NNN) – Tenant pays a base rent, taxes, and insurance expenses. Landlord responsibility is limited to roof and structure. Most common for net lease REITs.
Absolute Triple Net Lease – Tenant pays rent and all property-related expenses including taxes, insurance, maintenance, repairs, and utilities. The landlord receives passive rental income.
Within retail net lease REITs, common property types include big box stores, convenience stores, freestanding restaurants, and pharmacies.
Office, industrial, self-storage, healthcare, and auto dealerships are other sectors.
Key Benefits of Net Lease REIT Investing
Here are some of the major advantages that make net lease REITs an attractive investment:
Stable, Reliable Income – Long leases with contractual rent bumps provide secure and predictable growing cash flow. This supports consistent dividend payouts.
Portfolio Diversification – Net lease REITs offer diversification from stocks and bonds. The assets and dividends are not directly correlated with volatility in equity markets.
Inflation Hedge – Rental increases in net leases are often tied to CPI or fixed bumps, providing an inflation hedge.
Lower Volatility – Net lease REITs exhibit lower stock price volatility compared to other REIT property sectors.
Consistent High Occupancy – Properties stay almost fully leased given the long-term lease commitments tenants make. Limited downtime risk.
Limited Capital Expenses – With tenants covering maintenance costs, landlords retain more cash flow and keep their own capital spending lower.
Recession Resilience – Net lease REITs showed greater resilience during the 2008-09 financial crisis compared to other REIT property types.
For income investors, net lease REITs provide steady dividends with lower risk, along with diversification for their broader investment portfolio.
Potential Risks and Downsides
However, there are also some potential disadvantages for investors to be aware of:
Tenant Credit Risk – While diversified, poor financial health of even a few large tenants can negatively impact rent collection and cash flow, especially in recessions.
Lease Renewal Risk – Upon expiry, rental rates on renewed leases may be below expectation due to weaker market conditions.
Interest Rate Sensitivity – Like all REITs, rising interest rates can make net lease REIT dividends look less attractive relative to bonds.
Limited Appreciation – As specialized single-use assets, net lease properties may not appreciate in value as much as traditional commercial real estate.
Industry Concentration Risk – Portfolios concentrated in one property type like restaurants would face larger impacts if that sector declined.
Re-leasing Risk – Specialized properties may be harder to re-lease if vacated by a tenant bankruptcy or restructuring.
Prudent investors should assess metrics like tenant credit quality, debt levels, lease expirations, rent coverage ratios, and property diversification before investing in net lease REITs.
Top Public Net Lease REITs
The net lease REIT sector is relatively concentrated with around 10 major players focused on the space.
Here are some of the largest and most prominent publicly traded net lease REITs:
Realty Income (O) – The pioneering net lease REIT with over 6,500 properties leased mostly to retail tenants. Known as the “Monthly Dividend Company”.
STORE Capital (STOR) – Diversified net lease REIT with over 3,500 properties in retail, services, manufacturing, healthcare, and other sectors.
National Retail Properties – One of the largest retail-focused net lease REITs, owning over 3,000 properties leased to convenience stores, restaurants, and retailers.
Broadstone Net Lease (BNL) – Fast-growing net lease REIT owning industrial, healthcare, office and retail properties. Focus on top U.S. markets.
VEREIT (VER) – Commercial net lease REIT with quick service restaurant, convenience store, and retail brand tenants. Owns over 3,800 properties.
Essential Properties (EPRT) – Smaller net lease REIT focused on middle-market tenants like restaurants, early childhood centers, car washes, and medical offices.
Spirit Realty (SRC) – Retail-focused net lease REIT owning over 1,700 properties leased to retailers, restaurants, services, and other industries.
W.P. Carey (WPC) – Diversified global net lease REIT. The portfolio includes retail, industrial, and self-storage, offices across the U.S. and Europe.
This covers most of the major net lease REITs, but there are many smaller niche players as well catering to specific sectors.
Overall the net lease REIT market capital is approximately $85 billion as of 2022.
Key Metrics for Analyzing Net Lease REITs
When researching and comparing net lease REIT investment options, here are some of the most important metrics for investors to look at:
Occupancy Rate – Higher occupancy indicates tenant retention success and income stability. Look for 95%+ occupancy consistently.
Weighted Average Lease Term – The remaining lease term directly impacts predictable cash flow duration. 8-12+ years is ideal.
Rent Escalators – Contractual rent increases protect against inflation. CPI bumps or fixed annual bumps are best.
Tenant Credit Quality – Assess the financial strength of tenants via credit rating, sales growth, and industry health metrics.
Tenant & Industry Diversification – Broader tenant and industry exposure limit risk concentration.
Debt Metrics & Credit Rating – Conservative leverage ratios protect dividends through market cycles. Investment grade rating ideal.
FFO Growth Trends – Rising Funds from Operations per share signals financial health and growth prospects.
Dividend Yield – Higher yield compensates more for income but assesses payout ratio sustainability.
Dividend Growth History – Look for consistent annual dividend increases over longer time periods like 5-10 years.
Analyzing metrics related to tenants, lease terms, property focus, financial health, leverage, and dividends is crucial for making informed net lease REIT investments.
Tips for Analyzing Net Lease REITs
When researching net lease REITs, here are some detailed tips for conducting due diligence:
- Review top tenants – assess their credit, importance to rental income, sales/profitability trends, and broader industry dynamics.
- Check lease expiration schedule – are many leases renewing in the near term? Is concentration risk increasing?
- Look at historical occupancy rates through market cycles – has the REIT maintained high occupancy consistently even in recessions?
- Examine debt profile – favor conservative leverage and interest coverage metrics, investment grade rating. Check for adequate liquidity.
- Study market rent analysis in investor presentations – Is there upside potential compared to in-place rents upon renewal?
- Learn management’s strategy for external growth – what is their acquisition pipeline? How do they source deals?
- Assess the REIT’s track record of integrating acquisitions operationally and financially.
- Review historical FFO and dividend growth rates – favor a long track record of consistent growth over 5-10 years through cycles.
- Check alignment of management incentives with shareholders – insider ownership percentages.
- Look at relative valuation metrics like current Price/FFO compared to past years and industry peers.
- Review analyst reports from Wall Street for informed institutional opinions on the REIT.
Doing thorough tenant, industry, management, and financial analysis is crucial before making any substantial investment in a net lease REIT.
Constructing a Diversified Net Lease REIT Portfolio
Net lease REITs can play an important role in most income investor portfolios. Here are some tips for constructing a diversified net lease allocation:
- Diversify across 8-12 net lease REITs to mitigate individual tenant, sector, and geographic risks.
- Allocate 5-10% of the overall portfolio to net lease REITs for stable growing retirement income.
- Combine larger established blue chips with some faster-growing small-mid cap REITs for a blend of yield, growth, and risk profiles.
- Consider sector-specific names like retail, restaurant, or industrial net lease REITs for more targeted sub-sector exposure.
- Reinvest dividends through DRIP plans to accumulate shares and compound total returns.
- Rebalance annually as some names appreciate faster than others. Trim overweight positions.
- Utilize tax-advantaged accounts like IRAs to avoid taxes on dividends and capital gains.
- Dollar-cost averages into positions over time, buying more shares on price dips.
Owning a basket of 8-12 net lease REITs can provide portfolio stability, diversification, durable income growth, and an inflation hedge.
Current Market Environment for Net Lease REITs
In assessing the near-term outlook, net lease REITs remain relatively attractive for income investors given:
- Continued low interest rates make dividend yields look compelling.
- Strong protection against inflation with rent bumps in existing leases.
- High tenant demand for net lease properties as uncertainty lingers.
- Healthy balance sheets and access to capital enable external growth.
- Potential for landlords to achieve above-market renewal rents as leases expire.
However, with REIT equity valuations elevated after the pandemic rebound, being selective and patient may allow long-term investors to lock in better entry dividend yields on net lease REITs.
Conclusion
Net lease REITs offer many benefits like stable growing dividends, diversification, attractive yields, and an inflation hedge.
However, risks related to tenant credit, lease expirations, and property sector concentrations should be evaluated closely.
Using the research tips provided, investors can prudently analyze net lease REITs and construct a diversified portfolio allocation.
For income-oriented investors, net lease REITs can provide durable and growing retirement income along with protection against inflation over the long run.
Frequently Asked Questions
What is a net lease in real estate?
A net lease is a lease agreement where the tenant pays all or most of the operating expenses for the property in addition to rent. The landlord receives passive income with fewer expenses.
What’s the difference between a triple net and a double net lease?
In a double net lease, the tenant pays base rent plus property taxes and insurance. In a triple-net lease, the tenant also pays maintenance costs.
Do net lease REITs pay monthly dividends?
Some net lease REITs like Realty Income and STAG Industrial pay monthly dividends, while most pay quarterly. Monthly dividends allow investors to compound returns faster.
What is a bond equivalent yield?
Bond equivalent yield allows a comparison of REIT dividends to bond yields. It shows the annual bond yield needed to match the REIT’s dividend payments over 12 months.
Are net lease REITs good for retirement income?
Yes, net lease REITs can provide steady, reliable retirement income. The triple-net structure minimizes expenses, providing secure dividends. Long leases give consistent income.
Which net lease REIT is the safest?
Realty Income and National Retail Properties are considered among the safest net lease REITs, with strong tenant credit quality, long remaining leases, and conservative management.
What is a cap rate in real estate?
Cap rate means capitalization rate, which is the ratio of a property’s net operating income to its current market value. It measures the expected rate of return.
How do rising interest rates affect net lease REITs?
Rising rates make bonds relatively more attractive, which can lead to some investors rotating out of REITs. However, established net lease REITs often continue performing well in rising-rate environments.
