There are a lot of moving parts when it comes to investing in real estate, from location to tenant quality, and a fair amount in between. However, there's one statistic that probably doesn't get nearly enough consideration from investors, and that's the weighted average lease term. Here's why W.P. Carey (WPC +1.83%) stands tall on this figure, and why it is important to consider when you compare it to net lease peers like Realty Income (O +1.06%) and NNN REIT (NNN +0.99%).
Net lease REITs keep it simple
Owning and operating a property can be a lot of work, which is why W.P. Carey, Realty Income, and NNN REIT (formerly known as National Retail Properties) use the net lease approach. Essentially, they all own single-tenant properties for which the tenant is responsible for most asset-level operating costs. It materially reduces the time and energy that these REITs have to put in to maintain their portfolios.
NYSE: WPC
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Tenants are happy to take on these costs and obligations because, by paying them, they are effectively ensuring that the property is maintained to whatever standard they see fit. Net lease properties are often acquired via sale/leaseback transactions that are used by the seller to raise cash for other purposes. Essentially, W.P. Carey, Realty Income, and NNN REIT are more like financial partners than landlords in many ways. In exchange for the cash they provide in the sale/leaseback deals, they get reliable tenants and low-maintenance properties.
A key factor here is that the leases that get signed generally have very attractive features for the REIT. For example, there are often regular rent increases built into the leases. W.P. Carey, specifically, has long focused on including inflation-linked rent hikes (54% of its leases), which has been a real benefit of late given the spike in inflation.
The general idea is to create a reliable business to support shareholder dividends. The leader of reliability here is probably NNN REIT, which has 34 years of annual dividend hikes behind it. Realty Income is at 29 years. And W.P. Carey's figure is roughly 25 years, but that number is better than it seems because it has increased the payment every year since its 1998 IPO.
NYSE: O
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Long lease terms help with the hard times
That said, reliably increasing a dividend requires a strong foundation. Just owning net lease properties isn't enough -- a REIT also needs to focus on tenant quality and strong property locations. Assuming that these things are in hand, another important factor to consider is lease length.
Realty Income, NNN REIT, and W.P. Carey are three of the largest, oldest, and most highly respected net lease REITs. Given their dividend histories, it's also safe to assume they each have a good handle on running a net lease portfolio.
However, W.P. Carey's average weighted lease term is 11.2 years. That compares to 10.2 years for NNN REIT and 9.6 years for Realty Income. Simply put, W.P. Carey has locked in its tenants for longer, and that gives it a slightly more reliable revenue stream. It could be enough to tip the scale if you are comparing this trio of net lease peers.
NYSE: NNN
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It is more relevant than you may think. A rule of thumb is that the average business cycle is around seven to 11 years long, depending on what is happening in the world. Having a longer average remaining lease term means that the rental income W.P. Carey collects is better protected from future economic downturns. Simple math will tell you that, with plenty of time remaining on the average lease, tenants are expected to keep paying through at least a full business cycle.
It's not that the remaining lease terms for Realty Income or NNN REIT are bad, per se -- they just aren't quite as good. And when you combine that with W.P. Carey's higher yield of 6.5%, compared to 5.7% and 5.4%, respectively, for NNN REIT and Realty Income, it's one more check mark in W.P. Carey's favor.
Minor differences can add up
Realty Income, NNN REIT, and W.P. Carey are all very well-run net lease REITs. You probably wouldn't be making a mistake by buying any of them. However, if you are looking to own just one, W.P. Carey's dividend yield is higher, its dividend history is equally strong, and it has locked in its tenants for longer. Alone, none of these facts is enough to differentiate the REIT, but together they start to build a very compelling investment thesis.
