The Triple-Net Playground Is Getting Highly Disruptive But Agree Realty Is Still A Perfect Kid

Apr.11.13 | About: Agree Realty (ADC)

The Triple-Net REIT playground is becoming more and more crowded today with non-listed REITs rushing to create liquidity events for investors. In addition, many non-REITs are looking to also cash in on the REIT craze by way of converting to more tax-friendly publicly-listed securities.

The most recent Triple-Net deal in play with Cole Credit Property Trust III (CCPT3) has created a bidding war in which two arch rivals - Cole Holdings and American Realty Capital Properties (ARCP) - are pumping fists at each other in hopes to win the prized REIT - CCPT3 - that owns 1,014 properties in 47 states. Recently I wrote an article describing the playground battle in progress:

Withstanding the fact that ARCP has no experience in managing multi-tenant retail or office properties (and way over-priced), my biggest issue with the "playground bully" is ARCP's externally managed platform. In my opinion, ARCP is using shareholder resources to wage an attack on Cole Holdings. I see no other reason for ARCP to acquire the CCPT3's portfolio at an implied 5.2% cap rate, other than to become the king of the non-traded REIT playground.

It's clear to see that all REITs are benefiting from historically low interest rates and that has fueled their growth over the past several years. However, it's also clear that certain sectors are becoming more pricey and even with low cost capital, some of the higher valuations cannot be justified. As I explained in a recent Seeking Alpha article:

Given the hunger for yield, REITs have been able to fund acquisitions quite easily, and that continues to drive down capitalization rates (cap rates) - or the income generated from a property divided by its value. Accordingly, the driving force behind cap rate compression - strong demand for stable income-producing investments - has made it much easier for REITs to access low-cost debt (or ease of raising equity), and that, in turn, has led to a scarcity of good-quality properties on the market.

In that same article, I provided the harbinger for cap rate compression:

Investors take caution! Cap rates have compressed to historically low levels and in this low interest rate period, one should consider the continued widening of the risk curve. Remember that investing consists of exactly one thing: dealing with the future.

Agree Realty: A Standout Student

I have three kids in elementary school and recently all of them have come home with a "Terrific Kid" award. That's good news for a parent since that means that none of them have been a visitor in the principal's office. I like it when they all stay under the radar and bring home coupons for free food at Chick-fil-A.

In the Triple-Net classroom, I consider Agree Realty (NYSE:ADC) to be a "terrific kid." Like my younger bambino, Agree does not set any big records but they always show up ready to perform the best, every day.

Founded in 1971 by Richard Agree, Chairman and CEO, and public since 1994, Agree Realty Corporation has been in operation for over 42 years (and has been public for 19 years). With a current market capitalization of around $394 million, Agree is considered a small-cap REIT with 109 properties (100 single-tenant and 9 shopping centers) in its portfolio and over 3.3 million square feet in 27 states. Here is a snapshot of properties owned:

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Like many of the other Triple-Net REITs, Agree operates its investment platform with a variety of free-standing net lease tenants including many household names such as Walgreens (WAG), CVS (NYSE:CVS), Staples, Chase Bank, AutoZone (NYSE:AZO), Advance Auto Parts (NYSE:AAP), Lowe's (NYSE:LOW), McDonald's (NYSE:MCD), Family Dollar (NYSE:FDO), Harris Teeter, Dollar General (NYSE:DG), and Wawa. As shown below, Agree has a majority (88%) of nationally-recognized tenants, including many investment grade retailers (62.6%).

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Agree's portfolio has an average lease duration of 17 years - the highest in the sector. In addition, the company has well-staggered lease expirations that mitigate rollover risk.

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Agree has a proven track record for managing portfolio risk. During the Great Recession, Agree was successful in negotiating property dispositions, lease amendments, and lender work-outs with Borders. In addition, the company sold a former Borders store last May (2012) while also extending leases with Kmart (NASDAQ:SHLD) and Best Buy (NYSE:BBY). Also, last year, Agree disposed off 3 Kmart anchored shopping centers that reduced the portion of Agree's rental income attributable to Kmart by 29%. Proceeds from the sales during 2012 amounted to approximately $16.1 million.

Agree's recession-resistant investment strategy has paid off as the company's occupancy rate has increased from 93% in 2011 to 98% in 2012.

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Agree has done an excellent job at widening its diversification and during the fourth quarter the company acquired properties leased to Mattress Firm in Morrow, Georgia; Harris Teeter in Charlotte, North Carolina; a Dollar General Market in Lyons, Georgia; Big Lots in Fuquay-Varina, North Carolina; AutoZone in Minneapolis, Minnesota; LA Fitness in Lake Zurich, Illinois; and Advance Auto Parts in Lebanon, Virginia; and a portfolio of four Applebee's located in Harlingen, Texas; Wichita Falls, Texas; and two in Pensacola, Florida.

Also, during 2012, Agree's acquisition activity totaled around $81 million - a record year for the company doubling any previous years. In 2012, Agree acquired 25 properties leased to 18 different retailers located in 15 states.

Agree also completed developments from McDonald's in Southfield, Michigan and JP Morgan Chase in Venice, Florida and the total development projects completed in 2012 was approximately $21 million.

Wawa is continuing to diversify its tenant base as well as its geographic profile:

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Why Does This Terrific Kid Stand Out?

As noted above, cap rates have compressed to record levels, especially in the Triple-Net sector. Agree, a much smaller REIT with a market cap of around $394 million, has been able to maintain a healthy balance sheet, although not as strong as the larger peers.

With assets of $334 million and debt of $117 million, Agree has a debt-to-enterprise value of approximately 34%. The Company's debt-to-enterprise value decreased to approximately 24% after taking in account the proceeds from its recent stock offering. Agree's interest coverage is healthy at 4.2 times and its debt-to-EBITDA ratio is at 5.6 times.

Because of its small size, Agree has been able to acquire many of its properties off-market (the company's average year one capitalization rate is around 8%). In addition, Agree's development platform provides considerable higher yielding (9%+) risk-adjusted returns that provide more organic (no broker fee) revenue. Here is a snapshot of Agree's historic Funds from Operations:

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In the fourth quarter (2012), Agree paid its 75th consecutive cash dividend. The dividend for the fourth quarter was $0.40 per share and it remains well-covered as both the current FFO payout ratio and the AFFO payout ratio are approximately 78%.

Also Agree recently announced that it had declared its first quarter 2013 dividend of $0.41 per share, up from $0.40 per share. When annualized, Agree's 2013 dividend is $1.64 per share, an increase of 2.5% compared to the previous annualized dividend amount of $1.60 per share. Here is a snapshot of Agree's dividend history:

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As you can see, Agree did cut its dividend in 2011 from $2.040 (in 2010) to $1.600 (in 2011). That was the only cut for Agree during its 19 year publicly-traded history.

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From a valuation perspective, Agree appears to be flying under the radar of its more "entertaining" playground friends. Based upon the FAST Graph below, Agree appears to be cheap with a P/FFO multiple of 12.5x. Moreover, it is also clear from the price (the black line) and FFO (the orange line) correlated graph below that the price is well below its tracked FFO.

The blue shaded area represents Agree's dividends distributed to shareholders. This consistent level of income distributions is an important aspect of the investment merit of this Triple-Net REIT. Therefore, based on the company's distributable cash flow, Agree represents a very attractively-valued REIT at today's levels. It may not be "silly" cheap, but the 5.6% current, and above-average growing yield, in today's low interest rate environment, is solid.

The biggest value that I see with Agree today is when comparing the well-behaved "perfect kid" with the larger more disruptive stand-alone peers. As referenced at the outset, CCPT3 has an offer from ARCP and Cole Holdings to acquire the portfolio of 1,000+ assets. Assuming we use the contemplated (assumed) cap rate of 5.2%, Agree's portfolio (based on income) would be worth around $900 million or approximately $66.00 per share.

Agree shares are trading at $29.74 - or around half of the valuation (using a cap rate of 5.2%). Now you can see the value of a "perfect kid." No disruptive attitude. No egos. No dream of being the "king of the jungle." Simply, a nimble and non-disruptive kid trying to carve out a small share of the Triple-Net playground.

Finally, here's the report card. Agree has racked up a year-over-year total return of 43.19%. That's not bad, especially when you consider the noise generated by the big boys: Realty Income (NYSE:O) 32.66%; National Retail Properties (NYSE:NNN) 47.44%; W.P. Carey (NYSE:WPC) 57.84%; Spirit Realty (NYSE:SRC) 35.44%; and American Realty Capital Properties 52.18%.

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Watch out, this perfect kid may become the next playground sensation. All it takes for greatness is for talent to be applied consistently. At least that's what I tell my kids... work hard and be humble and you can sleep well at night.

Source: SNL Financial, ADC Investor Presentation, FAST Graphs

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.