Triple net lease real estate investment trusts (REITs) have been gaining attention of late because of big acquisitions and industry consolidation. And there's about to be a passing of the crown from current industry heavyweight Realty Income (NYSE: O ) to upstart American Realty Capital Properties (NASDAQ: ARCP ) . This is all very exciting, but what happens next?
Let them pay rent -- and taxes, maintenance, and insurance
The triple-net lease business model is a good one. Essentially, REITs like Realty Income and National Retail Properties (NYSE: NNN ) have for years been buying stand-alone retail properties and leasing them back to the tenants. The leases are generally long-term in nature and contain regular rent increases. Better yet, the tenants are usually responsible for virtually all of the costs of the property.
That means National Retail gets to sit back and collect rent without having to lift a finger (or pay a dime) to maintain what it owns. It might seem odd for a retailer to sign up for a lease like that, but the alternative is to tie up precious growth capital in owning hundreds, if not thousands, of properties.
National Retail, which has been public since 1984, has built a portfolio of over 1,850 properties across 47 states and 38 industries. The REIT has increased its dividend for 24 consecutive years. While that's impressive, Realty Income's portfolio is over 3,850 properties strong across 49 states and 47 industries. Realty has increased its monthly distribution for 64 consecutive quarters.
A good business
Clearly, the triple-net lease model is a good one. That's why American Realty Capital Properties got into the business. It went public in late 2011 with a tiny portfolio of around 60 properties leased to two banks and Home Depot. Compared to the far more diversified Realty Income and National Retail, American Realty wasn't a particularly desirable REIT when it came public.
Through aggressive acquisition activity, however, American Realty is now set to unseat Realty Income as the largest triple-net lease REIT. Although not yet complete, the company has plans to buy fellow newcomer Cole Real Estate Investments (NYSE: COLE ) , growing its portfolio to over 3,700 properties and a combined market value that exceeds that of Realty Income. That's impressive growth for a company that's only been public for a couple of years.
American Realty's fight for the crown with Realty Income makes for good drama, but does it make for a good investment? That's the big question investors should be asking. After such rapid growth, American Realty is going to have to digest what it's bought -- the big growth is likely behind this REIT. Which could help explain why the price has fallen 15% or so over the last six months.
However, Realty Income's stock has fallen by just as much. National Retail has fallen around 10%. Some of this has to do with the broader REIT sell-off. However, investors shouldn't get complacent. With such large portfolios, neither Realty Income nor American Realty are likely to grow very fast from here.
Both would need to acquire another triple-net lease REIT to see a quick lift in their portfolios. Such a purchase would likely be very costly. And, part of successfully navigating this industry is being able to cherry pick the best properties. That gets harder to do when buying one or two has virtually no impact on the top or bottom lines.
At the end of the day, National Retail's smaller size gives it the best growth prospects, but the REIT's 5% dividend yield is the lowest of this trio. Realty Income, with an enviable track record and massive scale, has a 5.5% or so yield. Upstart American Realty, which has more operational risk right now, has a yield of around 7%. But investors shouldn't expect much more than that on the total return front once it consummates the Cole deal. That said, Realty Income's prospects aren't any brighter.
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