The adverse economic effects caused by the COVID-19 pandemic have been particularly hard on real estate investment trusts (REITs). The retail REITs have been hammered by store closures and declining foot traffic. Many in the mortgage REIT space had a near-death experience. Some investors used this downturn in the pricing of many REITs as an investment opportunity.

Berkshire Hathaway CEO Warren Buffett was one such investor and his company just took advantage of the weakness in the REIT space to increase Berkshire's position in STORE Capital (NYSE:STOR), a retail-focused triple-net lease REIT.

What makes this REIT a Warren Buffett stock? 

Exterior of big box store

Image source: Getty Images.

STORE helps companies operate more efficiently financially

The first part of STORE Capital's name is actually an acronym, which stands for Single Tenant Operational Real Estate. The company buys properties from business owners and then leases the property back to the owner under a triple-net lease model. In the triple-net lease model, the tenant is responsible for paying rent, insurance, taxes, and maintenance on the property. In this model, STORE Capital is largely conducting a financing transaction, and the tenant operates the property. STORE Capital's value proposition is that it helps business owners make their balance sheets more efficient, often removing mortgage debt burdens and some of the loan covenants that go along with them from the company's ledger. 

STORE Capital does intense due diligence on its tenants, and 72% of its tenant base produce revenues over $50 million per year. STORE Capital demands that its tenants provide unit-level financial reporting. The company also does intense research on the industries the tenants operate in and ensures they have a defensive moat to support strong lease performance. These are not mom-and-pop stores; these are large corporate clients with the financial wherewithal to survive an economic air pocket. Indeed, the company just reported that 90% of its tenants paid rent in December. 

A very Buffett-like business model

Warren Buffett's investment philosophy involves buying companies with business models that will survive market adversity. STORE Capital's tenants generally fall into three buckets: Service companies (fitness centers, restaurants, education), retail (big box, grocery stores), and manufacturing. The companies in each of these buckets have durable business models and are much more insulated from the economic cycle than individual retailers and/or services that are largely discretionary.

Investment philosophies of Benjamin Graham and David Dodd are mentioned in company presentations. STORE strives to buy buildings below replacement cost and to invest in properties with returns and yields above the brokered market. These strategies provide the company with a margin of safety that Graham (and Buffett) would appreciate. 

Buffett originally bought STORE Capital stock in 2017, and over the summer he increased his position to just under 10% of the company. Buffett was willing to look past the stock weakness, given that it was driven by a pandemic and not by anything inherently wrong with the business model. In Graham and Dodd parlance, STORE Capital was trading below intrinsic value due to the pandemic. 

STORE is still reporting year-over-year gains in funds from operations

In the third quarter, STORE reported adjusted funds from operations (AFFO) of $119 million, which was up slightly from the third quarter of 2019. AFFO per share for the trailing 12 months is $1.78 per share, which gives the company an earnings multiple of 17.3 times trailing 12 months AFFO. REITs generally use funds from operations in lieu of GAAP net income because it more accurately represents cash flows. Real estate investors have a lot of depreciation, which is a non-cash charge that tends to reduce earnings a lot. STORE pays a quarterly dividend of $0.36 per share, and it increased its dividend in September. At current levels, STORE provides a pretty decent yield of 4.7%, and its dividend works out to be about 81% of AFFO. 

The dramatic drop in interest rates gives STORE a chance to refinance its debt at more attractive rates, which should increase profitability, as rental rates won't be affected. The spread between STORE's return on properties and its cost of financing should widen. As more people get vaccinated, the pandemic will hopefully retreat, which will get people back into some of STORE Capital's service tenants. Warren Buffett clearly sees something in the stock, and income investors should take a look too. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.