Realty Income (O -0.70%) and National Retail Properties (NNN -0.80%) are the industry bellwethers in the net lease real estate investment trust (REIT) space. With 27 consecutive annual dividend increases at Realty Income and an even more impressive 29 at National Retail, conservative income investors really need to look at both before making a final stock purchase decision. This is more important now than ever before, too, because there are increasingly important differences between their businesses.

Here's what you need to know to make the call between the market's two favorite net lease REITs, though you might decide to pass on both before you're done reading.   

The net lease thing

REITs own property -- usually commercial or retail -- and lease it out to tenants. That's pretty simple to understand. However, net lease REITs do things a little differently. They own properties where the tenant is responsible for most of the asset's expenses, often including things like basic maintenance and taxes.

A woman using her finger to write the word 'dividends' on a piece of glass in front of her

Image source: Getty Images.

It's a fairly low-risk model for the property owner, but the arrangement can be a benefit to both sides of the transaction. A company that leases property gets to raise cash by selling an asset while still retaining the use of the property just like it owned it. The REIT exchanges cash for a property backed by a long-term lease that will require little additional maintenance or other costs. A win/win if ever there was one.

The net lease model is so compelling that there are now lots of REITs using it today, including the self-storage sector and casinos. What makes National Retail and Realty Income stand out is that they have been doing this for decades. And their incredible dividend track records are proof of their long-term success.

They are, without question, the largest and best-known players in the space. For many years, their portfolios were fairly similar, too. But that's started to change, and their business plans are not as interchangeable today.

Digging into the portfolios

National Retail is 100% focused on owning single-tenant retail properties such as convenience stores (7-Eleven, for example) and restaurants (Taco Bell and Denny's), it's two largest sectors. This REIT is also focused on U.S. assets, with broad diversification across the country. And with roughly 3,000 properties, it's pretty big. 

Realty Income is even bigger, with nearly 6,000 properties, but that's not the only difference. While once focused on retail assets like National Retail, Realty Income has started to branch out. Today, around 82% of its rent roll is retail, with industrial (11%), office (4%), and agriculture (2%, vineyards) making up the rest.

Although 18% may not sound like a huge part of the portfolio, it provides Realty Income with more avenues to grow its portfolio. The ability to expand has been helped by another change -- Realty just inked its first deal in the United Kingdom (about 2% of rents). That potentially opens Europe up to the company, as well.   

When it comes to growth, Realty Income has more levers to pull. But it will need those levers because its larger scale requires more transactions to maintain the growth rate for this larger property business. It had to expand beyond retail.

O Dividend Per Share (Quarterly) Chart

O Dividend Per Share (Quarterly) data by YCharts.

For potential investors, this raises the question: How focused do you want your portfolio to be? If you prefer diversification, then Realty Income is the easy winner here (and probably the slightly better option for most investors). If you like a company that focuses on what it knows best, then National Retail would have the edge.

As to which does it better, at the end of the day they both tend to increase dividends in the low- to mid-single-digit space annually.  

A valuation conundrum

So far, we have two large REITs doing similar things producing similar results for income investors. There are slight differences that might push you one way or the other, but nothing that would make you run screaming from either company.

The determining factor may be Wall Street. The long-term success these two REITs have achieved is no secret, and investors have bid the shares up accordingly.

Looking at the midpoint of Realty Income's adjusted funds from operations (AFFO) projection for 2019, it is currently trading at roughly 22 times AFFO. Price to AFFO is like the P/E ratio used to evaluate industrial companies. An AFFO of 22 means a relatively steep stock price. The dividend yield, meanwhile, is around 3.9%, way higher than the S&P 500 Index, but near the lowest levels in the company's history.

National Retail doesn't fare much better. Its price-to-AFFO multiple is roughly 20 times, using the midpoint of its 2019 projections. And its current yield of around 3.7% is also near the lowest levels in its history.  

O Dividend Yield (TTM) Chart

O Dividend Yield (TTM) data by YCharts.

Essentially, neither Realty Income nor National Retail Properties is cheap. In fact, the numbers indicate they are on the expensive side today. National Retail is a little cheaper, so it "wins" on the valuation front. But it also has a lower yield, so it's hard to suggest it's that much better of a deal. While both are reliable dividend payers, the mixture of historically low yields and higher valuations suggests most investors would be better off sitting on the sidelines.

Two for the wish list

Realty Income and National Retail Properties are iconic names in the net lease space with incredible histories. Both are very well-run REITs. You might prefer one or the other based on the important differences between them, most notably size and portfolio diversification, but neither would be a bad choice. And with elevated valuations and historically low yields, the wish list is where they should probably stay for now. They are both too expensive to buy today for most, if not all, investors.