STORE Capital (STOR) has homed in on a profitable niche in the commercial real estate sector. The real estate investment trust (REIT) concentrates on owning profit-center real estate. These buildings are essential to the operating company's ability to make money.
While it's a relatively narrow focus considering the overall size of the commercial real estate market, it's still an enormous opportunity. STORE Capital estimates that around 2 million locations worth $3.9 trillion fit into this category. It's the only REIT focused on the profitability of the underlying property, leaving it with a wide-open opportunity.
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What is profit-center real estate?
STORE Capital focuses on owning single-tenant operational real estate -- properties critical to the single tenant operating in the building. Examples include restaurants, auto dealerships, early childhood educational facilities, metal fabrication workshops, and food processing facilities.
Real estate investors typically acquire these free landing properties in sales-leaseback transactions with the owner-operator. The sale frees up capital that the operating company can use to expand, while the lease provides the purchaser with steady rental income. Most leases on single-tenant freestanding properties are triple net (NNN), which makes the tenant responsible for maintenance, building insurance, and real estate taxes, insulating the landlord from those rising costs.
Many REITs and real estate investors own single tenant net lease real estate. All focus on two factors when looking to purchase a property:
- Corporate credit quality: Does the tenant have the financial strength to meet their lease obligations?
- Real estate value: Does the underlying real estate have residual value if the current tenant leaves?
STORE Capital considers those factors, and a third one: Unit-level profitability. It evaluates whether the property is a profit driver for the operator. The company believes that profitability at the property level improves the overall credit profile of its portfolio, enabling it to produce even more durable rental income. The REIT requires that its tenants supply it with unit-level financial reporting so that it can continually monitor the underlying performance of the real estate it owns.
A gigantic opportunity
STORE Capital estimates that there are 2 million single-tenant commercial properties in the U.S., currently owned by about 215,000 companies. That gives it a total addressable market opportunity valued at $3.9 trillion. Given the enormity of this market, STORE Capital can be very selective about the properties it acquires by focusing on highly profitable locations.
The REIT currently owns 2,965 properties with over 100 million square feet of rentable space worth $11.2 billion. It leases these properties to 573 customers across 121 industries, primarily in the service (64% of its rent), manufacturing (20%), and service-oriented retail (16%) sectors. Its top five industries are full-service restaurants (7% of its base rent), early childhood education (6.1%), metal fabrication (5.9%), automotive repair and maintenance (5.6%), and health clubs (5.2%).
STORE Capital currently has another $13.2 billion of deals in its pipeline. These properties include those operated by companies in the manufacturing, RV/auto dealer, storage, specialty medical, entertainment, education, and restaurant industries.
A meaningful portion of that pipeline has come from the company's direct origination model. STORE Capital primarily works with growing regional and national companies, which provide it with repeat business. About a third of its new business comes from existing customers. The REIT will steadily acquire additional properties so that its customers can continue expanding their operations. The company's existing customers currently operate about 41,000 locations, providing the REIT with a large embedded pipeline of future acquisition opportunities.
STORE's focus on acquiring profit-center real estate has paid huge dividends for investors over the years. The REIT has grown its adjusted funds from operations (AFFO) per share at a 5.7% compound annual rate since its initial public offering in 2014. That has helped support 6.1% compound annual dividend per share growth during that period. Meanwhile, the REIT's growth rate is accelerating, with it forecasting AFFO per share growth of 6.3% to 8.3% in 2022.
A potentially profitable real estate investment
Even though STORE Capital has a laser-focused strategy, the REIT has an enormous growth opportunity ahead. Most companies still own their real estate, which might not be the best use of their capital. As a result, STORE has a wide-open opportunity to acquire this profit-center real estate. That should enable it to continue growing its AFFO and dividends per share at attractive rates in the coming years, which could make it a very profitable real estate investment over the long term.
