When the coronavirus pandemic hit in 2020, many stores got shut down, but those deemed essential stayed open. And that allowed the real estate investment trusts (REITs) that were their landlords to get through a difficult period in relative safety. For example, single-tenant property specialist Realty Income (O 0.70%) increased its dividend each quarter that year despite the pandemic.
Here's why you should consider adding a REIT that owns single-tenant properties to your portfolio.
So what about net leases?
Although not always the case, very often a single-tenant property is owned by a net lease REIT. What's so interesting here is that the tenant is responsible for most of the operating costs of the property it occupies, while the landlord, to vastly oversimplify things, simply collects the rent.
For any individual property, this is something of a high-risk proposition for the landlord, since the loss of that tenant would mean no more rent coming in. However, spread across a large enough portfolio, the individual property risk is greatly diminished. And thanks to the fact that the tenant is responsible for most property-level operating costs, it actually becomes a fairly low-risk approach for the landlord.
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As noted, Realty Income -- the largest net lease REIT, with over 10,000 properties -- sailed through 2020 without skipping a beat on the dividend front. So did peer National Retail Properties (NNN 0.10%), with around 3,200 properties, as it increased its dividend in the third quarter, just like it had for years. Both of these REITs increased their dividends again in 2021, by the way.
That's not to suggest that either of these REITs didn't face adversity. As with all landlords, there were concerns that tenants wouldn't pay. And some tenants did stop paying. But enough of their tenants were resilient to the headwinds that Realty Income and National Retail Properties -- two bellwether names in the net lease segment -- got through the period with their dividends in one piece. They are two of the best examples of how single-tenant properties can keep your income portfolio strong in good times and bad.
What you own counts, too
Location, location, location is one of the keys to real estate investing. However, what sits on the property is pretty important, too. When combined with location, this helps explain the strength this pair of REITs demonstrated during what was a very difficult period.
For example, some of Realty Income's largest tenants are groceries and drugstores, essential retailers that remained open because customers had to be able to shop for their basic needs. At the end of the third quarter, convenience stores made up 11.6% of the REIT's portfolio, followed closely by grocery stores at 10.9%, dollar stores at 7.5%, and drugstores at 7.2%. Total that up, and these high-traffic, regularly frequented necessity businesses make up roughly 37.2% of Realty Income's rent roll.
Certainly the REIT owns other businesses that were hard hit by coronavirus concerns, such as movie theaters (about 5.2% of rents), but the strength of its necessity-oriented tenants provided a foundation that has supported it through over two years of pandemic fears without a dividend cut.
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The story is roughly the same for National Retail Properties. Convenience stores make up around 17.6% of rents, with auto-related stores (repair shops and the like) at 12.1%, for a total of just under 30% of rents. National Retail Properties doesn't have the same exposure to grocery stores (0%) and drugstores (1.3%), as Realty Income, but that's in line with its focus on owning smaller properties in prime locations -- which are typically more generic in nature -- that it believes it can easily repurpose if there is a vacancy.
Essentially, management is cautious about larger properties that would be harder to fill -- for instance, if a grocery store went vacant, the most obvious new tenant would be another grocery store. That materially limits options. In this case, a strong core of necessity businesses and good locations, which could be easily filled in a vacancy, helped this REIT muddle through 2020 without a cut.
The proof is in the dividend history
The big story here, however, is that the single-tenant focus of Realty Income and National Retail Properties has shined for much longer than a single year. In fact, both of these industry icons offer roughly three decades' worth of annual dividend increases. That's the strength of the net lease approach, especially when REITs like these focus on conservative properties housing necessary businesses.
If you don't own a net lease REIT like Realty Income or National Retail Properties, you should probably consider a deep dive into one today.
