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Real estate investment trust (REIT) National Retail Properties (NYSE: NNN) is a bellwether name in the net lease space. But there are some issues investors need to understand before jumping aboard. Here's the lowdown on this REIT and why the next three years are likely to be pretty good to the REIT and its shareholders.
The basic business model
The first notable thing about National Retail is that it's a net lease REIT. That means it owns single-tenant properties for which the tenants are responsible for most of the operating expenses of the assets they occupy. Although a simplification, the REIT can just sit around and collect rent while its tenants do all the work. The net lease approach is generally considered low-risk, with the REIT making the difference between its rent rates and its cost of capital.
The second most important thing about National Retail Properties is right in the name -- it's 100% devoted to U.S. retail assets. It owns over 3,100 properties across 48 states, comprising 380-plus tenants.
It's also diversified by retail sectors, with tenants spread across more than 30 different "lines of trade." So it wouldn't be fair to describe the REIT as undiversified. Still, there's some notable concentrations, including 18% or so of rents coming from convenience stores, 10.5% from full-service restaurants, 10% from automotive services, and nearly 9% from limited-service restaurants.
The thing is, the company's model has worked quite well over the years. In fact, it's increased its dividend annually for more than three decades. You don't build a streak like that by accident; it takes hard work, a dedication to returning cash to investors, and a solid business model.
A rough patch
All this is why today is such an interesting time for National Retail Properties. When the coronavirus first hit and the entire world was basically being driven by fear, the REIT's rent collection rate fell to a disastrous 52% in April. That's terrible and largely a consequence of its retail focus. However, rent collection rates were back up to 94% in October, showing its business is still on pretty solid ground.
Wall Street, however, is still a little leery -- a potential opportunity for long-term investors. Historically, National Retail Properties' dividend yield has tracked along with that of fellow net lease industry icon Realty Income (NYSE: O). Right now, National Retail Properties' yield is 5.2% and Realty Income's is 4.6%. If history is any guide, those two yields will eventually converge again.
It's National Retail's performance over the next few years that will likely make that happen. For starters, the REIT increased its dividend in the third quarter. That was meant to be a sign of strength and proves it hasn't suddenly given up its commitment to dividend investors.
But more importantly, National Retail Properties will continue to execute the same boring business model that made it a Dividend Aristocrat in the first place. That means a slow, steady investment in new properties using a property-by-property acquisition approach.
In fact, if you step back from the rent collection issue, 2020 isn't actually all that bad a year from an operational standpoint. Through the first nine months of the year, National Retail Properties sold 25 properties and bought 21. That means the portfolio shrunk a little, but given the situation, this isn't a terrible thing.
Essentially, despite the headwinds, the REIT is clearly not in full retreat. Yes, in 2019 the REIT sold 16 properties and bought 79, but the coronavirus wasn't an issue then. And, as the next three years unfold, it's highly likely National Retail Properties gets back into growth mode again.
Watch the acquisitions
So the key issue here will be on the portfolio acquisition front, which is really what will signal a "return to normal." This is pretty exciting, given that the CEO specifically highlighted National Retail's growing acquisition pipeline in the company's third-quarter earnings release. As the REIT picks up the purchases, investors are likely to reward the REIT with a higher valuation.
Closing the valuation gap with Realty Income probably won't take a full three years, but that time period at least gives the REIT a little wiggle room. Indeed, in that span of time, this one-time industry darling is highly likely to have earned its way back into investors' hearts again.
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