Despite all of the closures and negative economic effects being created by the COVID-19 pandemic, some real estate investment trusts (REITs) are still collecting the vast majority of the rent they are owed. Mall REITs have been hit particularly hard, but the triple net lease sector has still managed to perform well throughout the crisis.
Realty Income's (O 0.24%) focus on tenants that offer essential services has so far helped it navigate this difficult economic environment.
Realty Income tenants include gas station operators, which have managed to stay open during the pandemic.Image source: Getty Images.
Rent collections have been improving
Commenting on the quarter during last week's earnings conference call, Realty Income CEO Sumit Roy discussed the company's situation with regards to collections and guidance:
We have collected 99.1% of contractual rent for the second quarter from investment-grade rated tenants, which further validates the importance of a high-quality real estate portfolio leased to large, well-capitalized clients. While we have not historically prioritized investment-grade rated tenants as a primary objective, during a period of economic uncertainty, high-grade credit tenants tend to provide more reliable streams of income, as the last few months have proven out.
The company went on to say that it collected 91.5% of contractual rent in July, which is its second consecutive month of improved rent collection and the highest since the pandemic began. That said, some of Realty Income's tenants are struggling, particularly movie theaters, health and fitness establishments, and restaurants. These industries accounted for approximately 81% of uncollected rent during the second quarter. Luckily many of these tenants are national chains, so they have more financial wherewithal than smaller independent gyms and restaurants. On the earnings call, Roy explained that Realty Income reached an agreement with AMC Entertainment (AMC) to pay back the deferred rent, which the movie theater operator started doing in July.
Triple net leases tend to have more reliable tenants
Realty Income is a triple net lease REIT, which means its tenants cover expenses like taxes, insurance, and maintenance. Triple net lease terms are generally multiyear, with automatic rent escalators. Most retail leases are gross leases wherein the tenant just pays rent. These are more common for offices, apartments, and enclosed malls. Triple net leases are mainly accessible to essentials and consumer nondiscretionary tenants that can thrive even in a tough economy.
Realty Income's top four tenant categories are drugstores, convenience stores, dollar stores, and supermarkets. Walgreen's (WBA -1.18%) is the largest single tenant, accounting for 6% of rental revenue. Overall, rent collections bottomed at 84.5% in May, and have been increasing ever since. Occupancy stands at 98.5%.
Adjusted funds from operations is still growing
During the second quarter, Realty Income reported net income of $0.31 a share and adjusted funds from operations (AFFO) of $0.86 a share. AFFO increased by 4.6% on a year-over-year basis, while revenues increased by 14.3%. The company also announced its 91st consecutive quarterly dividend increase. Based on its annualized per share dividend of $2.80, Realty Income has a dividend yield of 4.5%.
Triple net lease REITs are good investments for income investors in that they provide a decent dividend yield and the tenants are usually investment-grade. Realty Income is one of the classic Dividend Aristocrats. A diversified portfolio of tenants in essential and consumer nondiscretionary sectors makes for reliable results even when the economy turns south. Realty Income has always been one of those stocks that operates in such a way that its investors can sleep at night, and its performance during the COVID-19 pandemic demonstrates why that is.
