Financial Review Of The Debt Structure Of The 5 Biggest Triple Net Lease REITs

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Includes: NNN, O, SRC, VER, WPC
by: Robin Nieland

Summary

Last week, the Federal Reserve leaders decided not to increase the bank's key interest rate.

Which triple net lease REIT is best equipped to handle a possible future interest rate hike?

This article provides an overview of the debt structure of the 5 biggest Triple Net Lease REITs.

NNN and O seem the least sensitive to an interest rate hike in the short term.

Last week, the Federal Reserve ("Fed") leaders decided not to increase the bank's key interest rate. The Fed is still waiting for the right moment to raise interest rates. Some say that a possible rate hike could occur later this year, but that remains to be seen.

Recently, I wrote an article about the four biggest healthcare REITs and how sensitive they are to a future interest rate hike. I discussed various debt and financing metrics to compare the various REITs in that particular subsector. Some readers suggested I do a similar analysis on a different REIT subsector.

The main premise behind this (and my earlier) article is that a possible future rate hike will impact short-term share prices of almost every REIT, regardless of its actual sensitivity to interest rate changes. This article is meant to provide answers to the question: which triple net lease REIT is best equipped, from an operational perspective, to withstand rising rates in the future?

Triple Net Lease REITs

A triple net lease REIT usually invests in real estate where the tenant is responsible for paying the building's property taxes, insurance and costs associated with maintenance or repairs. Triple net leased properties are popular investment vehicles for investors seeking steady income with relatively low risk. The properties could include office buildings, shopping malls, industrial parks, or free-standing buildings operated by banks or restaurant chains. The biggest players in this segment are:

  • Realty Income (NYSE:O)
  • National Retail Properties (NYSE:NNN)
  • VEREIT, Inc. (NYSE:VER)
  • W.P. Carey (NYSE:WPC)
  • Spirit Realty Capital (NYSE:SRC)

Realty Income is by far the biggest triple net lease REIT in terms of market cap. It's two to three times bigger than all the other mentioned REITs. All data in this article are from the latest quarterly earnings reports (Q2 2016). Therefore, I did not take into account the financing activities for each of these companies between June 31 and today.

Capital structure

As a starting point in our analysis, let's take a look at the capital structure. The idea is that a REIT with high amount of debt financing (more leverage) is usually more sensitive to interest rate hikes. The table below provides a breakdown of the debt-to-equity (D/E) ratios of different REITs.

Source: Data from Morningstar

We can see rather big differences between the REITs. O and NNN are conservatively leveraged in comparison to the other REITs. Especially WPC's D/E ratio is quite high.

The next question is how much debt is variable-rate and how much is fixed-rate. The underlying rationale is that a higher amount of variable-rate debt is riskier than fixed-rated debt.

Source: Table created by author, data from latest Q2 2016 earnings and supplemental reports

Almost all of the triple net lease REITs have around 85-90% fixed-rate debt. WPC, however, has only 68% fixed-rate debt. It has a credit revolver, a term loan and various non-recourse debt issues with floating rates. These floating rates are based on an underlying benchmark rate (LIBOR). This means a possible interest rate hike would directly lead to a higher interest expense for a sizable part of WPC's debt portion.

Debt maturities

The amount of variable rate debt, however, is not the only indicator. Fixed-rated debt which matures in the short term is just as sensitive to rising interest rates as variable rate debt. The table below provides an overview of the amount of debt maturities between now and 2019 relative to the outstanding long-term total debt.

Source: Table created by author, data from latest Q2 2016 earnings and supplemental reports

An analysis of the debt maturity schedule shows that NNN has a lower amount of short-term debt maturities than its peers. The other REITs need to refinance roughly 45-50% of their debt before 2020. A rising interest rate will impact these REITs (especially VER) sooner, based on this indicator.

Another way to look at the debt maturity schedule is to calculate the maturity of the various debt instruments. The fixed-debt issues are, on average, up for refinancing in 5-6 years. The variable rate debt instruments have shorter maturities (2-3 years).

Source: Table created by author, data from latest Q2 2016 earnings and supplemental reports

NNN has the longest maturity (6.2 years) on its debt portfolio. This coincides with the relatively low amount of debt maturities until 2020. Other triple net lease REITs have maturities of roughly 4-5 years.

However, it's also important to check what the average rate of the maturing debt is. Debt with a relatively high interest rate that matures in the short term actually offers a chance to improve the financial operations. If a company is able to refinance expensive debt with cheap debt, it is a good thing. The table below provides an overview of the average weighted debt rate of the debt that matures between 2016 and 2019.

Source: Table created by author, data from latest Q2 2016 earnings and supplemental reports

On average, the maturing debt has an interest rate between 3.00% and 4.00%. Only NNN has a somewhat higher interest rate on the maturing debt, but the amount of maturing debt is relatively small. NNN seems to be positioned well if the company is able to refinance its debt in the current low rate environment.

Other indicators

In the section above, I've discussed the capital structure and the debt maturity schedule of the five triple net lease REITs. I will finalize my analysis of the rate sensitivity with a few more general indicators of the health of the companies as it relates to debt and interest payments.

Source: Table created by author, data from latest Q2 2016 earnings and supplemental reports

The (net) debt, cash and EBITDA numbers are all in million USD.

The net debt/EBITDA multiple shows how many years it would take for a company to pay back its debt. VER has the highest multiple, which is no surprise given the company's high D/E ratio. O and NN each have a multiple of around 5.0x. Again, this is no surprise, because the D/E ratios of these REITs are lower as well. However, this ratio and the D/E ratio are not exactly similar, because the net debt/EBITDA ratio takes into account the earnings of a company (and thus, the current operations). The D/E ratio is merely a snapshot view of the balance sheet.

The table below provides the interest rate coverage ratio.

Source: Table created by author, data from latest Q2 2016 earnings and supplemental reports

The interest coverage ratio measures a company's ability to pay the interest on its outstanding debt. On average, these companies have interest coverage ratios of roughly 3.0x-4.0x. NNN has a somewhat higher ratio. This is due to the fact that it utilizes the least amount of debt.

Summary

The table below provides a summary of the various indicators I have mentioned in this article. The number (1-5) represents the rank, where 1 is the best and 5 is the worst company, based solely on that indicator. Obviously, this table and the ordinal ranking system do not take into account the degree of differences between them.

From the data, we can obviously see that NNN is the best company in each of the examined metrics. Because of its low leverage ratio, NNN logically scores great as well on other indicators. The same goes more or less for O.

SRC is in the middle of the pack. It scores well because of its debt composition and maturities, but the debt ratios are below average. Finally, VER and WPC are both in the bottom of the pack. This does not mean they will default when rates are hiked, nor that they are (or will be) bad investments. It does, however, signal the fact that in comparison with other REITs (such as NNN and O), their debt structure is more prone to short-term interest rate risk. Mainly due to the fact that they are more leveraged than their peers, but also because of the debt composition and debt maturity schedule.

So all in all, NNN and O seem better equipped, from an operational perspective, to withstand rising rates in the future. This does not subsequently mean you should invest in both companies right now. I did not address future growth potential and valuation here. These are both important arguments for whether you should invest in the common shares or not. This analysis provides a starting point.

Author's Note: If you have thoughts about this article or interest rate sensitivity in general, please leave your reply in the comment section below. Furthermore, if you would like to be notified of my future articles, please follow me! (by clicking my name at the top of the page).

Disclosure: I/we 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.

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