STORE Capital (STOR) faced its first big challenge in 2020, and it survived. In fact, it did better than that: It put shareholders first and raised its dividend. The boost may have been a token amount, but that STORE was able to do that in a pandemic-challenged year speaks to the strength of the real estate investment trust's (REIT's) business model, and helps explain why its future is bright.
The way you do the things you do
As a net lease real estate investment trust, STORE Capital owns single-tenant properties for which the tenants are responsible for most of the operating costs. With a portfolio of nearly 2,800 properties, no single building has a material impact on its top or bottom lines. This combination of features, where a large portfolio can offset any single vacancy risk, results in a fairly low-risk business model for the real estate sector.
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On top of that, the REIT likes to work directly with companies in sale/leaseback transactions, which account for roughly 80% of its acquisitions. Essentially, it buys properties from companies that own their own stores, providing companies capital that they can use to invest in their businesses or to pay down debt. In return, those companies sign long-term leases for the assets they just sold, locking in tenants for STORE. The REIT's average lease length is roughly 13.5 years, which is easily long enough to get the REIT through the ups and downs of the economy. And it seems as though its lessees like working with it, because around a third of its purchases involve repeat customers.
The really interesting thing here, however, is that originating its own leases in direct sale/leaseback transactions also has some notable benefits. For example, ahead of these deals, STORE gets to dive into a company's books, including taking a close look at the performance of the specific locations they are considering buying. That gives the REIT a better gauge of how strong a property really is, and it can easily pass on those that aren't up to its standards. Moreover, STORE Capital sets the lease terms, including contractually based rent hikes that it expects to add around 2.5% per year to its growth.
The best part is that all of this is highly repeatable. In fact, the REIT has been executing this same basic strategy since its IPO in late 2014, when it had just 850 properties -- less than a third of its current number.
Where to from here?
Since the REIT has added nearly 2,000 additional properties to its portfolio in the seven or so years of its public life, and its model is repeatable, the big question is: How far can it go? STORE Capital management estimates that its addressable market is around $3.9 trillion in size. Its portfolio's value is around $10.3 billion today, so there's ample opportunity for growth.
STOR Market Cap data by YCharts
But you don't have to take STORE Capital's word on that. Take a look at the net-lease segment's bellwether name, Realty Income (O 1.46%). After its recent acquisition of VEREIT, that REIT now has a portfolio of more than 10,000 properties. But, more important, Realty Income doesn't see its size as an impediment. In fact, it thinks being bigger adds to its advantages.
Those benefits include the ability to spread business expenses over more properties, which keeps costs down. Then there's access to capital markets, which is often easier for larger companies than smaller ones. Its ability to issue debt at lower interest rates makes it easier to turn a profit, as does its ability to sell stock when needed at advantageous levels. And then there's Realty Income's capacity to take on larger deals that smaller peers couldn't handle. STORE probably won't enjoy that last benefit for a while, but the others are all on the horizon (or already accessible to it) as it gains scale and recognition in the market. And as long as it sticks to its clearly successful playbook, there's no reason to think it won't be able to get much bigger than it is today.
Growth -- that's what investors should expect
All in all, the best is yet to come for STORE because it has a sizable business that's built on a strong foundation. That should serve it well as it looks to increase its scale through further direct sale/leaseback transactions. And investors should benefit along the way from regular dividend increases. Yes, the ongoing pandemic has created some near-term headwinds, but STORE Capital's success through this period just strengthens the case for its long-term potential. Bigger is the future here, and income investors should like that story a lot. At the current share price, it yields about 4.5%. That yield has been higher at times, but sometimes it's worth paying a premium for a company with strong growth prospects.
