With the start of the new year, investors are beginning to focus on a potential recession in 2023. During recessions, the investor playbook is a little different, and companies with extremely stable business plans become the stars. Agree Realty (ADC 0.72%) is a retail real estate investment trust (REIT) that has heavy exposure to defensive companies. Is it worth picking up in the new year?
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Not all leases are the same
Agree Realty is a net lease REIT. Net lease REITs are different than the more typical gross lease that most people encounter when renting an apartment. In a gross lease, the tenant is responsible for the rent and little else. Net leases require the tenant to cover the operating costs of the property, including insurance, maintenance, and real estate taxes. These leases tend to last a decade or more and contain automatic escalators. They tend to be expensive to break, so both parties need to be financially capable of handling economic bumps in the road.
NYSE: ADC
Key Data Points
Agree pursues recession- and e-commerce-resistant tenants
Agree Realty's strategy is to focus on tenants that are omni-channel critical, which means that they have both an online and physical presence and are e-commerce-resistant. Agree also focuses on defensive companies that are recession-resistant -- in other words, retailers that focus more on consumer non-discretionary instead of consumer discretionary. Agree also avoids retailers with private equity sponsorship, as it considers these retailers to be over-leveraged (in other words, they have too much debt). If you look at Agree's top sectors, they include grocery stores, home improvement stores, and tire and auto stores.
At the end of the third quarter of 2022, Agree Realty had over 1,700 properties with about 200 ground leases. Ground leases are different than the typical net lease in that the tenant develops the property. Agree reported that occupancy was 99.7%.
Agree Realty's balance sheet can weather an economic storm
Agree Realty's balance sheet is conservative, with over $250 million in cash and limited debt maturities until 2028. 12-month trailing core funds from operations per share came in at $3.88. REITs generally use funds from operations to express earnings instead of net income. This is because net income under generally accepted accounting principles requires the company to deduct a lot of depreciation and amortization, which is a non-cash charge and may not reflect the value of its properties. This means that net income tends to understate the cash flow generation capacity of the company. So at current levels, Agree is trading at 18.3 times trailing core FFO per share.
Agree has outperformed the competition this year
Agree pays a monthly dividend, and it hiked its dividend twice in 2022. Currently, the stock yields 4.1%, which is lower than peers like Realty Income (O 1.17%) and National Retail Properties (NNN 0.93%). All three companies have similar business models. Agree Realty has outperformed both companies during 2022.
Agree probably outperformed in 2022 due to its superior growth compared to National Realty. Realty Income is hard to compare because it did a merger with Vereit in 2022, which overstates the growth when you look at the income statement.
Bottom line: A safe port in the storm
Given the possibility of a recession next year, investors should think about defensive stocks. Income investors should, as a general rule, have some of their portfolio in net lease REIT stocks. These companies generally offer security, low risk, and a steadily increasing dividend yield. Overall, Agree has one of the more conservative balance sheets out there and has no meaningful debt repayments for several years. If we hit a deep recession, Agree Realty should outperform most other stocks.
