Using the spread between 10-year and three-month Treasury rates as a gauge, economists estimate the probability of a U.S. recession occurring within the next 12 months at 66%. With an economic downturn looking more likely than not by next summer, now is still an appropriate time to prepare your portfolio for such an event.
One way to do so is to buy shares of companies with a record of raising their dividends through times of economic turmoil. Having delivered 34 consecutive years of payout increases, NNN REIT (NNN -0.66%) has done so through the Gulf War recession, the dot-com recession, the Great Recession, and the COVID-19 recession. Let's take a closer look at what makes the business exceptionally reliable.
NNN's business model is battle-tested
NNN REIT specializes in buying single-tenant, net-lease retail properties from clients. This means that the company buys retail properties where there is only one tenant occupying the building. The client selling the property to NNN REIT agrees to pay a monthly base rent, as well as all taxes, insurance, and maintenance costs associated with a leased property, which makes it a triple-net-lease contract. These lease terms are often for a period of at least 10 years as well, with clauses for built-in rent growth. That builds visibility into the real estate investment trust's (REIT) steadily rising rent revenue base.
What's in it for the seller-tenant? Well, the proceeds they receive from such a deal can be used in any way the company chooses, including debt repayment or to capitalize on growth opportunities. This explains how NNN REIT's portfolio has grown to nearly 3,500 properties throughout the U.S. as of June 30.
Because single-tenant retail properties are smaller and the company has a more relationship-based approach to acquisitions, it faces less competition for properties from other REITs. This helps the company acquire assets at higher cap rates (e.g., 7.1% in Q2 2023). That gives it a good investment spread between its cap rates secured and its borrowing cost when also taking the investment-grade balance sheet into account. For instance, the company recently issued $500 million of notes at an interest rate of 5.6%.
Such an approach has also kept NNN REIT's occupancy rate above 96% throughout its history. That is why the company has been able to generate 4.9% annual average core funds from operations (FFO) per share growth since 2016.
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The market-smashing payout is handily covered
NNN REIT's 5.9% dividend yield registers at nearly quadruple the S&P 500 index's 1.6% yield. And for investors who don't mind modest annual dividend growth of 3% to 4%, the stock seems to be a solid pick.
This is because NNN REIT's dividend payout ratio is expected to come in at just below 70% in 2023. Factoring in debt and share issuances, this allows the company to raise the funds needed to meet its acquisition volume forecast of between $600 million and $700 million for 2023. That activity is what should continue to fuel core FFO per share growth.
A downright cheap valuation
Because interest rates have risen and the risk-free rate has soared to 4.4% (i.e., the 30-year U.S. Treasury bill), REITs have performed poorly across the board over the past 12 months. Down 15% during that time, NNN is no exception.
This sell-off has pushed the company's price-to-book (P/B) ratio to a two-year low of 1.7, which is materially less than the median P/B ratio of 2. As interest rates eventually begin to ease, analysts expect a recovery in NNN REIT's share price: The average 12-month target is $46, which would offer 14% upside from the current $39. That is why I believe shares of NNN are currently a buy for income-oriented investors.
