Earnings Update: Net Lease REITs (Q2 2024)

Important Note

Before going into today's article, I wanted to let you know that we will soon conduct interviews with the management teams of the following REITs:

• VICI Properties (VICI)

• Farmland Partners (FPI)

• Easterly Government Properties (DEA)

• BSR REIT (HOM.U:CA / OTCPK:BSRTF)

• Safehold (SAFE)

• Cibus Nordic (CIBUS)

• Canadian Net REIT (NET.UN:CA)

Let me know if you have any questions for them and I will make sure to ask them for you. You can put your questions in the comment section below.

Thanks!

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Earnings Update: Net Lease REITs (Q2 2024)

In our last Earnings Update For Net Lease REITs (Q1 2024), we summarized why we love net lease REITs by saying that they "play defense well during rising rate environments, and they play offense well during falling rate environments."

Over the last month, as the economy loses steam and the expected beginning of Fed rate cuts creeps closer, net lease REITs have strongly outperformed the market.

Over the last month, the 10-year Treasury yield has fallen over 35 basis points to about 3.9% as of this writing. During that time, the 7 net lease REITs in our US portfolios surged an average 8.9%, compared to the S&P 500's (SPY) 4.8% decline.

Data by YCharts

We would note that the three net lease REITs considered most recession-resistant -- Agree Realty (ADC), VICI Properties (VICI), and NNN REIT (NNN) -- have performed the best over the last month as recession fears have intermixed with rate cut excitement.

Although net lease REITs are often thought of as bond proxies, they are more than that. As we've commented in the past, the net lease model offers several major benefits:

• Long lease terms typically 10-20 years in length (plus multiple 5-year optional extension periods) provide high revenue and cash flow stability and predictability.

• Tenants are typically responsible for all or most property expenses such as maintenance, insurance, and real estate taxes. This protects the landlord/investor from inflationary operating expense increases.

• Contractual rent increases typically range from 1-3% annually, depending on the tenant and property type. This provides some organic NOI growth.

• Smartly locking in long-term debt can drastically reduce refinancing risk.

• By issuing capital and investing it in a way that generates a sustainable cash return above one's cost of capital, net lease REITs can boost growth by expanding their portfolios.

The above factors make for a setup where net lease REITs offer not only an attractive dividend yield but also a growing income stream via dividend hikes over time. Compare that to the fixed coupons of bonds.

Over the past few years of rising interest rates, net lease REIT stock prices have performed poorly for multiple reasons.

The first reason is their association with bonds in investors' minds. Generally speaking, net lease REIT stock prices follow bond prices.

The second reason is that external (acquisition) growth slowed in 2022 and 2023 as the market's forward-looking mechanism raised the cost of capital for net lease REITs faster than for private investors.

This year, however, that situation reversed. Net lease REITs have been rallying, lowering their cost of equity, while the cost of capital remains prohibitively high for most private investors in this space.

Hence we find that public REITs' share of single-tenant retail net lease deals fell from 27% in 2021 (a period of very low cost of capital for everyone) to 15-19% in 2022-2023, then rebounded to an abnormally high 38% in the first half of 2024.

Northmarq

For at least another few quarters, public REITs should continue to enjoy a strong cost of capital advantage over private investors, allowing them to scoop up billions of dollars of net lease properties at high investment spreads.

Thus, the fundamental performance of our 7 net lease REITs could be very different in the second half of the year than in the first half.

Even so, let's look at their Q2 results to see what we can learn.

• Essential Properties Realty (EPRT): click here for investment thesis

• Agree Realty (ADC): click here for investment thesis

• EPR Properties (EPR): click here for investment thesis

• NNN REIT (NNN): click here for investment thesis

• VICI Properties (VICI): click here for investment thesis

• W.P. Carey (WPC): click here for investment thesis

• Modiv Industrial (MDV): click here for investment thesis

Afterward, we'll look at which ones make the best buys today.

Essential Properties Realty Trust (EPRT): EPRT demonstrated once again in Q2 why it is the quintessential anchor position for our Core Portfolio. The REIT invested a quarterly record $334 million into single-tenant retail net lease properties at a weighted average cash cap rate of 8.0% and weighted average rent escalation of 1.9% annually. All (100%) of these acquisitions require unit-level financial reporting, while 76% are part of master leases covering multiple properties with cross-default provisions. Finally, the weighted average lease term of these sale-leaseback acquisitions was 17.8 years, signifying that initial lease terms tend to be either 20-years or 15 years with a slight tilt toward the 20-year option. Meanwhile, the balance sheet remains in top-notch shape at a net debt to EBITDA ratio of 4.6x. AFFO per share rose 4.9% in both Q2 and 1H 2024. At an AFFO multiple of 16.7x, EPRT now has somewhat minimal upside to its 17-18x fair valuation but remains a strong, steady, and reliable compounder that should deliver above-average returns with below-average risk over the long run.