Recently, the U.S. Census Bureau released its estimate of April retail sales. Overall sales fell 16.4% from March and were down 21.6% versus a year ago. This is a breathtaking drop in sales never experienced in the U.S. before, at least since we have been keeping records.
Clothing and accessory sales were down 89% year over year. This is a nightmare for mall real estate investment trusts (REITs), and many are struggling with tenants that can't make the rent.
But how is the crisis affecting the triple-net lease REITs?
How these leases differ
Realty Income (NYSE:O) is one of the best known of the triple-net lease operators. It specializes in stand-alone triple-net leases, which means the tenant is responsible for ongoing property expenses like real estate taxes, maintenance, and building insurance on top of paying for utilities and rent. Triple-net leases also tend to be longer-term leases.
The typical mall REIT will use gross leases, which means the mall operator must handle maintenance, insurance, and other costs. Gross leases are generally more expensive to the tenant, but a higher risk to the REIT. Triple-net leases are the opposite: lower risk to the REIT, but the rents are typically lower.
Despite closures, Realty Income collected most of the rent in April
During April, Realty Income collected 83% of contracted rent, and pretty much everything that was expected from the investment-grade tenants. Of the 17% that was not received, the vast majority came from theaters, restaurants, child care centers, and health and fitness businesses. So far, the company has been pursuing rent deferrals, not rent abatement. Realty Income has also been rejecting requests for deferrals that appear to be mainly opportunistic.
Its corporate strategy has been to pursue clients that are largely recession-resistant. The top four tenants are convenience stores, grocery stores, dollar stores, and drug stores, which represent 37% of revenue.
The problem sectors
Realty Income gave insight into some of the weaker sectors on the fiscal 2020 first-quarter conference call in early May. While the REIT was positioned for a recession, the pandemic's social-distancing requirements are something else altogether. Businesses hit a brick wall, going from generating profits to generating zero revenue overnight.
The theater industry represents about 6% of Realty Income's revenue. While it will take time for people to feel comfortable returning to theaters, the company is bullish on the industry going forward, believing that the higher margins on theater releases will keep Hollywood releasing movies to theaters and that theaters will recover from what appears to be a temporary downturn. Realty Income is modeling a three- to four-month turnaround for theaters, while health and fitness businesses should rebound quicker. Casual dining and child care will be more difficult, but Realty Income's tenants are national chains, which have the balance sheets to better help them weather the crisis, at least compared with mom-and-pop operators.
The REIT's own balance sheet is solid, with cash and borrowing capacity
During the first quarter, Realty Income took down $1.2 billion in lines of credit. The company also has another $1.1 billion in capacity on another revolving credit line. Between 2020 and 2021, Realty Income has $400 million of debt coming due. The company was confident enough in its situation to raise its dividend in March.
On the conference call, Realty Income noted that many of its tenants have been able to raise liquidity as well, either through a bank loan or a private investment in public equity (PIPE) deal (which involves selling public shares, preferred stock, or convertible security to private investors outside of a public offering). Realty Income's collections ended up being a bit better in April than the company originally anticipated. It expects that May's collections will be similar to April, and the fact that states are beginning to reopen is helpful.
Overall, Realty Income is in a much more solid position than some of the other retail REITs. Its portfolio of largely investment-grade tenants deal in consumer essentials and have been permitted to stay open. Of the clients that have been unable to open, most are associated with large companies that have more financial resources to weather the storm than others. While it is too early to declare the COVID crisis over, Realty Income has so far been able to navigate these waters better than most.