During the past three years, National Retail Properties (NNN -1.62%) and W.P. Carey (WPC -1.28%) have smoked the S&P 500 and created massive total returns for shareholders.
Source: YCharts.
However, for investors who missed the run -- or those considering reinvesting -- it begs the question: Can growth continue?
I believe the answer is yes for two reasons. First, while the economy has recovered nicely during the last five years, it still has a ways to go before it's "fully recovered." Second, the threat of rising interest rates should create opportunistic investing for both companies.
1. Still potential for growth
As a sector, equity REITs are cyclical -- or, they perform best when the economy is growing. This is because, in a strong economy, tenants are less likely to default on their rent. Also, a flourishing economy encourages expansion, creating more acquisition opportunities.
One of the key measures for economic growth is the unemployment rate. Since 2009, the U.S. unemployment rate has improved substantially. However, according to the President of the Federal Reserve in Minnesota, Narayana Kocherlakota, today's figure (6.1%) may not accurately display the true employment scenario. In fact, the number of employed individuals in their prime working years is the lowest its been since the mid 1980s.
Source: Bureau of Labor Statistics.
Another important indicator is construction. This was one of the worst-hit sectors following the financial crisis, and one of the slowest to recover. The good news is that, during the last two years, the industry has rebounded. This will be important for both National Retail and W.P. Carey. First, because it indicates a stronger economy; and second, it creates potential buying opportunities.
Source: YCharts.
2. Rising interest rates
National Retail and W.P. Carey's chief acquisition strategy is through sale-leasebacks. Essentially, both companies buy real estate from an existing business, and rent it back to them.
The incentive for businesses is threefold: They can remove a large real estate asset from their books, they don't have to worry about selling the property when the lease is up -- if they wish to leave -- and they can trade their mortgage for a fixed rate.
Of the three, the last is the most important. Businesses will often have a floating interest rate on their mortgage. While this leaves the company open to the risk of rising interest rates increasing their borrowing costs, interest rates during the last five years have been at rock bottom.
However, whether it's one or two years down the road, interest rates will increase. This should create an incentive for businesses to lock-in costs by trading their floating-rate mortgage for a fixed-rate payment -- like a rent payment to an equity REIT -- and create acquisition opportunities for both companies.
Last word
During the last five years, the economy has shown strong improvement. According to consensus predictions from the Federal Reserve, we're likely to see slow and steady progress continue during the next few years.
While growth is never certain, I believe the potential is there, and the environment will create a platform for continued expansion. For that reason, along with having proven track records of maintaining stability while creating returns, I think both National Retail Properties and W.P. Carey make great investments today.
