However, there's one exception. Berkshire owns one REIT in its portfolio -- Store Capital (STOR). Here's a rundown of what this REIT does, what makes it different from its competition, and why Buffett and the rest of Berkshire's stock-picking team may have decided to buy it.
What does Store Capital do?
Store Capital is a net-lease real estate investment trust, or REIT. If you aren't familiar with the term "net lease," it refers to a type of real estate lease structure that requires the tenants to cover variable expenses -- specifically, property taxes, insurance, and maintenance.
This is in contrast to many other types of commercial real estate, such as apartments, hotels, or office buildings, where the landlord covers these costs. Net leases are generally signed with long (10-15 years or more) initial terms with annual rent increases, or escalators, built into the agreement. In other words, net leases allow the landlord to create a predictable and growing income stream for more than a decade into the future.
Net-lease properties are generally occupied by a single tenant and are especially common in the retail and service industries.
Store Capital owns a portfolio of 2,084 properties, most of which are occupied by either retail- or service-based tenants. The average lease has about 14 years left on its term, and rent increases at an average rate of 1.8% per year on existing leases.
Just to give you an idea of the types of properties Store Capital owns, major components of its portfolio are restaurants, early childhood education centers, furniture stores, movie theaters, and health clubs. In all, about two-thirds of the portfolio is occupied by service-based tenants, with the rest occupied by retail and manufacturing businesses.
The key takeaway is that, although e-commerce is certainly wreaking havoc on some parts of the retail industry, Store's portfolio is mostly e-commerce-resistant. Service-based businesses are obviously not too vulnerable to e-commerce competition, and most of Store's retail tenants have an experiential component. For example, people generally like to see furniture in person before buying it.
Many Buffett-stock qualities
So why did Warren Buffett or one of his trusted stock pickers invest in Store Capital? We don't know for sure, but the stock definitely has some qualities that we know Buffett finds appealing. Just to name a few:
- The net-lease structure likely is appealing to Berkshire's stock pickers. While a net lease doesn't exactly provide guaranteed income, it's pretty close. Long lease terms, built-in rent increases (average annual increase of 1.8%), and the lack of unpredictable costs, like property taxes and building maintenance, could certainly have appealed to Berkshire.
- Store Capital's properties are 99.7% occupied. This is extremely strong, even for a net-lease REIT. About three-fourths of Store's tenants have investment-grade credit ratings.
- Store Capital requires tenants to provide building-level financial statements. This is a unique aspect of Store's business model and allows the company to monitor the financial health of its tenants and take appropriate steps to mitigate any perceived risks, as needed.
- While net-lease real estate may sound like a rather specific focus, the market is actually quite enormous. Store estimates that the net-lease profit center real estate market is over $3 trillion in size. So there's lots of room to grow, which Buffett loves to see.
- Store Capital pays a generous and well-covered 4.3% dividend yield that increases regularly. In fact, the company has increased its payout by 24% since 2014. This is a higher rate of increase than Store's peers, and its 70% payout ratio is quite low for a REIT.
One other potential reason Berkshire decided to acquire its Store Capital stake is that it was rather cheap. At the time of Berkshire's investment, Store Capital was trading for significantly less than it is today, mainly because of fears about rising interest rates and e-commerce headwinds affecting the brick-and-mortar retail industry. In fact, Berkshire paid $20.25 per share for Store Capital -- about 30% less than the current stock price, just over one year later.
As we know, Buffett loves being greedy when others are fearful and likes to do it by buying the best-in-breed stocks in beaten-down industries. That's how Berkshire came to own Bank of America and Goldman Sachs, both of which he invested in during the aftermath of the financial crisis, just to name a recent example, and valuation could have played a big role in the decision to invest in Store Capital.
While we don't know the precise reasons Berkshire bought Store Capital and we may never know them, it's fair to say that the investment has many of the qualities Buffett likes to see, and it was trading for a steep discount at the time of the purchase.
Is now a good time to buy?
As I mentioned, Store Capital is significantly more expensive than it was when Buffett bought it, so it's obviously not as great of a bargain as Buffett received. However, this is still a wide-moat company with a lot of room to grow that trades at less than 16 times its expected 2018 adjusted FFO (the REIT version of "earnings"), so I wouldn't call it expensive, by any means. In a nutshell, Store Capital still looks like an attractive long-term opportunity, and I'd be surprised if it doesn't remain a component of Berkshire's portfolio for years to come.