Real estate investment trusts (REITs) have struggled over the past 18 months as the Federal Reserve aggressively hiked the federal funds rate to combat inflation. This has raised the financing costs of these companies, and since they often trade based on their dividend yield, they have fallen in tandem with the bond market. Office and retail commercial real estate, meanwhile, have been under pressure this year over concern that maturing debt will have to be refinanced at much higher interest rates. NNN REIT (NNN -0.66%) is a large retail REIT with a nationwide presence and a 5.7% dividend yield. Is the dividend sustainable?
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NNN REIT is a triple-net lease REIT
NNN REIT is a triple-net lease REIT, which means it focuses on single-tenant properties under the triple-net lease structure. Most leases are called gross leases, where the tenant is responsible for paying rent and not much else. If you rent an apartment, you probably have a gross lease. A triple-net lease requires the tenant to absorb most of the property's costs, including taxes, insurance, and maintenance. These leases generally last more than 10 years and have automatic rent escalators. They are expensive to break, which means effective tenant choice is a must.
NNN REIT focuses on tenants in defensive industries
NNN REIT has 3,479 properties with 35.5 million square feet of gross leasable area as of June 30. The company operates in 48 states. The biggest tenant categories include restaurants, convenience stores, and auto services. These businesses are relatively defensive, which means they are more resilient in a recession than retailers that sell more discretionary goods.
NNN REIT has forecast 2023 funds from operations (FFO) of between $3.17 and $3.22 per share. REITs generally prefer to quote earnings in funds from operations (FFO) in addition to reporting net income as required under generally accepted accounting principles (GAAP). This is because depreciation and amortization is a huge expense for real estate companies, though it isn't a cash charge. This means that net income tends to understate the cash-flow-generating capacity of the REIT.
NNN REIT's dividend is well covered by FFO
Based on the company's FFO-per-share projection, NNN REIT's annual dividend of $2.26 is more than amply covered by the company's estimated FFO. NNN REIT just hiked its dividend in July, and the company has a 34-year track record of consecutive dividend increases. Based on the midpoint of its forecast, NNN REIT's payout ratio (the dividend divided by FFO) is 70.7%, which is pretty low for a REIT, given that they are required to pay out most of their income as dividends to maintain their tax-advantaged status.
NNN REIT's has minimal near-term debt maturities
Most of NNN REITs debt is long-term, with a weighted average maturity of 12.3 years. NNN REIT has no more debt maturities this year and only $350 million of debt maturing in 2024, which is less than 10% of its debt outstanding. NNN REIT is a conservatively run REIT with relatively predictable cash flows, as evidenced by its 34-year streak of dividend increases and its conservative payout ratio. Investors who are concerned about a possible recession and/or a hard landing might find NNN REIT to be a relatively low risk source of income.
