National Retail Properties (NNN +0.36%) is an old hand in the net-lease property business, with an impressive streak of 33 consecutive annual dividend increases under its belt. That makes it a Dividend Aristocrat.
Here's the thing: You don't achieve a record like that by accident, and the proof is in an odd little quirk about the real estate investment trust's (REIT's) portfolio -- it has never inked a deal with its largest tenant, 7-Eleven. Here's why you should care.
A unique approach
The first thing to note about National Retail Properties is that it owns single-tenant properties for which its lessees are responsible for most of the operating costs of the assets they occupy. This is what's known as a net lease. Any single property has significant risk associated with a vacancy, given that there is only one tenant. However, spread across a large portfolio, this is a very low-risk way for a REIT to operate. National Retail Properties owns nearly 3,200 properties.
Image source: Getty Images.
A lot of REITs use the net-lease approach, so this isn't that unique. However, there are other factors that set this Dividend Aristocrat apart. For starters, it is focused exclusively on retail properties. And as it looks at those properties, it tries to buy a specific kind of asset, favoring locations that are good for the current tenant and that could be re-rented easily to another one. That includes modest current rents, which are easy for tenants to afford, as well as locations that are on busy roads.
How does the REIT know that it's on the right track? The first big indication is that between 2007 and 2021, just over 70% of its sale-leaseback deals came from customers with which it was already doing business. And, just as interesting, the average cap rate for these deals was 7.6%, compared to the rest of its purchases, which averaged around 7.4%. Clearly, National Retail Properties' customers see value in what it is offering.
A wrinkle
But there's one more factor that's worth examining here. In addition to paying close attention to the properties it buys, National Retail Properties also makes sure it is working with a particular kind of tenant. It favors "selective non-investment-grade tenants" over investment-grade tenants. Why? For starters, it can charge them more rent. However, there's also the opportunity for credit improvement through operator mergers and acquisitions.
Basically, if it picks good companies to work with, these companies could get bought out by even better ones. These types of transactions improve the overall quality of the portfolio for the REIT and its investors. And because of the relationship nature of National Retail's sale-leaseback deals, it usually gets its pick of the best properties. These are exactly the ones that are most likely to stay open after a tenant gets bought out. But how big a deal is this?
During National Retail Properties' third-quarter 2021 earnings conference call, in response to an analyst question, Chief Executive Officer Julian Whitehurst noted:
...you mentioned 7-Eleven as our top tenant. We have done zero business directly with 7-Eleven. All of our 7-Eleven exposure in the portfolio is -- was originally transactions that we did with strong regional operators who grew and ultimately were acquired by 7-Eleven in one fashion or another. And to the extent we have other operators who also get acquired by 7-Eleven in the future -- I don't know that, that will ever happen. But if it did happen, 7-Eleven would become an even bigger tenant of ours, but we would not worry about that. We keep an eye on it, but we would not lose sleep over that. That -- our 7-Eleven real estate is some of our best real estate at some of our best prices and yields of anything in the portfolio.
The company's exposure to 7-Eleven amounts to 139 properties and accounts for 4.9% of rents. While that's hardly a number that's worrisome, it is also not a small figure.
Essentially, there are two big takeaways. You know you have a good business model when your customers want to keep doing business with you. But you know it's a really good model when you work with tenants that are getting swallowed up by one of the biggest and best operators in the convenience-store sector -- with such frequency that the acquiring company is your largest tenant, even though you've never bought a single property from them. And, notably, those locations generally stay open.
NNN Dividend Yield data by YCharts
Differentiated by design
National Retail Properties generally trades at a premium price, offering a similar yield to net-lease industry bellwether Realty Income, which has a different business approach. That said, National Retail Properties' consistent and successful business model is a key reason for the premium it is usually afforded.
However, following the pandemic downturn in 2020, National Retail Properties' yield is now 4.8% compared to Realty Income's 4.3%. There could be an opportunity for long-term investors here, assuming that National Retail Properties' continued success eventually causes that spread to narrow again.
