Swiftly rising interest rates make it more expensive to buy properties because it costs more to finance transactions. The solution is for asset prices to decline, but the math isn't quite that simple because human beings are involved in the mix.
Which is why Broadstone Net Lease (BNL -0.14%) is biding its time right now. But it isn't wasting its time. Here's what you need to know about this 6.8%-yielding dividend stock.
Modestly sized and careful about growth
Broadstone owns around 800 net lease properties. Compared to a giant like Realty Income (O -0.17%), with more than 13,000 properties, Broadstone is a pipsqueak. That said, the tiny REIT has grown rapidly.
Image source: Getty Images.
Between 2015 and 2019, the REIT bought between $500 million and $680 million a year in new assets. In 2020, that number plunged to just $100 million, but that made sense given the uncertainty surrounding the coronavirus pandemic.
In 2021, spending picked up to $655 million, and in 2022, it rose to $900 million. Unfortunately, the pace of growth is set to slow down again in 2023, thanks to rising interest rates.
In fact, in the first half of 2023, Broadstone actually sold around $120 million of assets while only buying about $80 million. Effectively, it is shrinking its portfolio, which isn't necessarily a good thing for investors who bought it hoping for steady growth. And yet, the decision to pull back actually makes a lot of sense from a risk/reward standpoint.
Adjusting to the environment
One of the biggest uncertainties is interest rates. They have risen dramatically, which increases acquisition costs. Property prices have to come down in order for deals to make economic sense. But there's a problem: The people who own properties tend to be slow to react to changes of this nature. They know what a property used to be worth and will stick to that price for as long as they can. That might mean not selling the property or only selling when they are forced to.
That can happen if the owner is a developer, and it needs cash for the next project. Or it can happen if the owner has a loan coming due and needs cash to pay it off. But for now, property prices are too high for Broadstone, and the REIT has no plans of chasing assets it views as overpriced. Instead, it is taking advantage of the slow industry reaction to higher rates.
While some investors are still willing to pay premium prices for assets, Broadstone is selling at what it believes are attractive levels. That cash is being used to build up some dry powder for when property prices become more in tune with the prevailing interest rate environment.
In the meantime, it is stepping in to provide loans to construction projects as banks and other traditional lenders have stepped out of the market (thanks at least partly to the bank runs that took place earlier in 2023).
That's not the company's main business, nor does management really want it to be. But if there's value to be created while it awaits better uses of cash (like buying reasonably priced net lease properties), it will make hay while the sun is shining.
It has one particular deal that's nearing the finish line that is notable on this front. A temperature-controlled warehouse in Florida will likely end up in the portfolio once it's complete in late 2024. But management noted that it probably couldn't have afforded the property at that point if it weren't making this deal. So the early construction-loan investment is likely to pay off handsomely for investors, assuming the loan agreement is consummated as expected.
Prudently attractive
The current net lease backdrop is tough, and investors have soured on the sector, with a particular distaste for smaller REITs like Broadstone. However, this net lease REIT is reacting in an intelligent and risk-conscious fashion while still trying to build value for shareholders. That's exactly what an investor should want to see.
Add in the big 6.8% yield (by comparison, Realty Income's yield is roughly 5.1%), and more-aggressive income investors might be tempted to jump aboard.
