American Realty Capital Trust: A Compelling Growth And Income Play

| About: American Realty (ARCT)

As a wealth manger with an abundance of clients in or near retirement, there is a universal need among my clients for stable income, plus safety of principal, and a little growth would be nice -- oh yeah, could we get something with preferred tax treatment as well?

I am presently recommending American Realty Capital Trust (ARCT) as one vehicle to meet those objectives. I have been watching this portfolio since the beginning of 2011, before ARCT became publicly traded, and I put many clients into it before the offering closed at $10 per share in June of 2011.

The portfolio consists of 485 properties in totaling an approximate value of $2 billion. ARCT started acquiring properties in 2008. It was a scary time to be a buyer, but in retrospect, it was the best time.

Tenants such as FedEx (NYSE:FDX), PNC Bank (NYSE:PNC), Walgreens (WAG), and CVS (NYSE:CVS) help round out an extremely high-quality portfolio. The properties were acquired at an average cap rate of over 8%. According to ARCT Chairman and founder Nick Schorsch, with whom I spoke on the phone, the REIT has only 30% leverage with average maturity of 5.1 years and an average rate of 4.4%.

All of the leases are triple net which means tenants are responsible for repairs. This keeps the cash flow consistent and predictable. Naturally rent increases are built into the leases.

Income: As of April 10th, the REIT is trading around 10.75 per share and is yielding 6.4%. This yield is very attractive, especially considering that the tenants are 92% rated and 71% investment grade. This compares favorably to similar REITS like National Retail Properties (NNN), which is yielding about 5.5% but is a much older portfolio and only about 10% investment grade tenants. ARCT is a relative bargain.

Growth: Besides the extraordinary yield, there are two factors which bode well for price appreciation. Within 2 to 3 months, ARCT must be included in MSCI and the Russell 2000. This will require purchases on the open market of ARCT by these indexes, which will amount to 14% to 16% of the total outstanding shares. Secondly, management has reported 13 to 15% growth in earnings, and the board will review a dividend increase next quarter. Clearly a dividend increase should drive the price up as well.

Tax Treatment: Most of the dividends paid by the relatively young ARCT REIT are not currently taxable, due to depreciation flow through of the underlying real estate holdings. So a 6.4% tax-deferred interest rate that ultimately will be taxed as a capital gain is obviously that much more attractive.

Since real estate is cyclical, you always need to be careful not to invest in real estate at the top of the market, like in 2007. However, I asked Schorsch about this. According to him, the outlook for retail commercial property is bright:

Debt is extremely cheap right now. More importantly, the spread between the 10 year Treasury around 2% and having the ability to buy property at cap rates of up to 8% is incredible.

Disclosure: I am long ARCT.