The COVID-19 pandemic has upended the models of many businesses that were once thought to be boringly stable. Retail-focused real estate investment trusts (REITs) like STORE Capital (STOR) have been in the direct line of fire from the coronavirus's economic impacts.
The business metric that everyone seems to be focused on when it comes to these REITs is their percentage of rent collection. That's important, but in fact, it reflects a bigger and more fundamental question that STORE Capital will soon have to answer.
How net lease REITs do business
STORE Capital is a net lease real estate investment trust competing with peers such as Realty Income, National Retail Properties, and W.P. Carey. The basic model is similar for all four. A company that owns a building sells it to the REIT to free up cash for other purposes. The former owner then generally enters into a long-term lease that requires it to pay for most of the property's operating costs. It's a win/win: The REIT gets a new property and the rents that come with it, while the seller gets an immediate infusion of cash while retaining the use of what is usually a core asset. The net lease model has withstood the test of time.
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As proof of that, National Retail Properties has increased its dividend annually for 30 consecutive years. Realty Income's streak is up to 27 years. And W.P. Carey's is 23 years, which is basically every year since it went public. But just because a company has a great dividend history doesn't mean it will continue to increase its payouts. For example, both Realty Income and W.P. Carey have increased their dividends in 2020. National Retail Properties has not, and based on its April rent collection rate of roughly 50%, there's a real risk it may hold off doing so until the COVID-19 pandemic runs its course. In fact, if its rent collection rate doesn't materially improve, National Retail Properties could be forced to cut its payout.
For reference, Realty Income's rent collection in the first quarter averaged out to around 85%. It hit a low point of 83.5% in May, but started to improve again in June. W.P. Carey's rent collection rate never dipped below 95% and was at 98% in June.
So how does all of this relate back to STORE?
A young company's first big challenge
National Retail Properties, Realty Income, and W.P. Carey have all been around for decades and gone through difficult economic periods before. They've proven that they can survive adversity while continuing to reward investors with increasing dividends. STORE Capital only went public in late 2014; the last material headwind in the REIT space was the 2007 to 2009 recession, which was over before it went public. Thus, this is the first economic downturn STORE Capital has faced in its six years as a public company.
So yes, investors should pay close attention to STORE Capital's rent collection, but the bigger and more important question is: How does the company handle adversity? So far, the answer isn't clear.
On the rent collection front, STORE Capital's April rate was 68%. That's not nearly as good as W.P. Carey, but not nearly as bad as National Retail Properties. It was also a bit short of what Realty Income was able to collect. Rent collection improved to 76% in June, but that was still short of where W.P. Carey and Realty Income landed.
That should add to investors' concerns about whether STORE Capital will be able to keep paying its dividend, let alone increase it. But the company did offer up some investor-friendly news: It announced on June 15 that its next dividend would match the previous payout of $0.35 per share. At this point, then, management is putting shareholders front and center in its thinking, which is what investors have come to expect from net lease REITs.
But will the portfolio of properties the company has built allow it to continue paying that dividend? To be fair, that question has to be asked of National Retail Properties as well. Note that both REITs generally increase their dividends annually with their third-quarter payments, so the next announcements on that score will be important ones. That said, the issue for STORE, which likes to originate its own leases, is how good a job it did picking properties and tenants when times were good. If the model STORE Capital has is as strong as management wants investors to believe, then it should muddle through this period without a dividend cut -- and maybe, if rent collections pick up enough, provide a token increase before the year is out. A dividend cut, however, would tell investors pretty clearly that STORE's approach isn't as solid as those of some of its key competitors.
The tide is out
There's an oft-quoted quip of Warren Buffett that says one finds out who has been skinny-dipping when the tide goes out. Well, the economy is at low tide now, so investors will soon learn if STORE Capital has what it takes to stand toe to toe with industry peers like Realty Income and W.P. Carey. Keeping an eye on metrics like rent collections and dividend payouts remains important. But the real question that needs to be answered is how well this young REIT is built to handle adversity.
