If you go to a restaurant and get terrible service, you probably won't want to go back again, no matter how good the food was. But a place with middling food and great service might actually become an old favorite simply because of the pleasurable experience. That's the core story behind National Retail Properties' (NNN 0.25%) long-term success. And its service bonafides are shining bright right now.
A tough market
Recently, Four Corners Property Trust (FCPT 0.93%) talked about how pricing has increased in the net lease space, specifically for restaurants. Net lease properties are leased to single tenants that are responsible for paying most of the property-level costs of the assets they occupy. During the real estate investment trust's (REIT) third-quarter 2021 earnings conference call, it noted that portfolio deals, which group multiple properties together into a single sale, are getting priced at a premium. Normally, such asset sales would come with a discount. It's a sign of heady times.
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Four Corners Director Patrick Wernig noted specifically that, "...the pricing environment was very competitive for restaurants and retail net lease in general." The REIT, which was spun off from Darden Restaurants in 2015, is trying to stick to its target cap rate in the mid 6% range, but finding deals can be hard. One key avenue for Four Corners is inking deals with existing tenants.
This has always been the approach of National Retail Properties. It has allowed the retail-focused net lease REIT to increase its dividend annually for more than three decades. And National Retail had some interesting things to say on the topic in its third-quarter conference call.
Relationships matter
Since 2007, 71% of National Retail Investors' acquisitions have come from companies with which it has a pre-existing relationship. That's no small figure, either, representing nearly $6 billion in purchases. About $2.5 billion in acquisitions (29%) have been market or auction transactions. Clearly, National Retail likes to work with companies it already knows well.
And it has proven pretty successful, with the average cap rate on acquisitions through the first nine months of 2021 sitting at 6.5%. That has been achieved despite the increased competition noted by Four Corners. Even National Retail has highlighted the tight pricing environment, explaining in its third-quarter call that cap rates are flat but near historic lows.
National Retail CEO Julian Whitehurst notes, however, that when dealing with a relationship tenant, "the cap rate is not the only driver of the value proposition." For example, it can be alluring to a seller to quickly get a deal done with a trusted partner (certainty of close). For the buyer, meanwhile, working with a longtime tenant can mean getting their best locations. For National Retail, lease length is also a key focus. In the third quarter, its new acquisitions came with average leases of 19 years, which is long enough to span roughly two and a half economic cycles and provides a great deal of consistency to cash flows.
National Retail's approach may mean slower growth than you might find from a REIT that is buying things in a fast and furious fashion. Indeed, if you are buying from current tenants, you have to wait for them to be ready to sell, while keeping in close contact even while they aren't ready so you stay top of mind. However, growth at any cost isn't necessarily good growth. For more conservative types, slow and steady could be the better option, noting that this REIT pays close attention to cap rates and its customer relationships as it looks to create a good deal for everyone involved. And when everybody wins, your best tenants come back to give you their best future deals. That's a formula that has proven itself through the entire cycle, multiple times, and one investors shouldn't underestimate.
Know what you own
National Retail Properties is a Dividend Aristocrat for a reason, and a big piece of that is its focus on serving customers well so they turn into repeat customers. It's not as sexy, perhaps, as a REIT that's using aggressive acquisitions, sometimes regardless of cost, to quickly build a portfolio. But National Retail's slow, steady, and disciplined approach has provided consistently strong results for dividend investors for more than 30 years. Conservative investors looking for a net lease REIT would do well to dig into the National Retail story, even if its approach only ends up providing a benchmark for other names you are considering.
