But as you have heard before, you can't expect to earn extraordinary results by doing what everyone else is doing. Why? Simply because by definition, most people aren't getting extraordinary results.
If everyone is focused on tech stocks, crypto, and SPACs, perhaps it may be time to look elsewhere for opportunities.
That's what I am doing, and today, the biggest investment in my portfolio is something that's very rarely covered on Seeking Alpha or elsewhere.
It is what we call "triple net leases", and in what follows, I will explain why I expect extraordinary results from these investments, and how you can profit from them as well.
Triple Net Lease Investments
A triple net lease is a specific kind of real estate investment.
You are probably asking yourself: what's extraordinary about that?
And if you have no real estate background, I understand your skepticism. From the surface, triple net leases look like boring retail real estate investments.
But it is the details that make all the difference.
Unlike a traditional real estate investment, triple net leases enjoy many advantages that typically result in higher returns with lower risk, and we think that these attributes will become particularly valuable in the years ahead.
Here is what I am referring to:
- Extremely long lease terms: triple net leases commonly have a 15-20 year initial lease term with several 5-year extension options. Therefore, your risk of vacancy is very low as long as you have a good tenant.
- Automatic rent increases: each year, the rent typically rises by 2%, and this is already pre-agreed at the time of signing the lease. Therefore, you can expect steady growth, regardless of market conditions.
- No landlord responsibilities: what this means is that the tenant is responsible for paying all property expenses, including utilities, property taxes, insurance, and even maintenance. Therefore, you receive a "net" return that isn't diluted by a bunch of expenses.
- Strong tenants: most often, the tenants are grocery stores, convenience stores, fast service restaurants, pharmacies, gas stations, etc., and other recession and e-commerce-resistant businesses. Rent coverage ratios are commonly 2-3x, and therefore, there is good margin of safety even if business conditions deteriorate.
- High land value component: if the tenant fails, which is rare, you can always release the building to another competitor, and in a worst-case scenario, you can just tear it down, and start all over again. Most of the value is in the land because triple net lease properties are commonly located on precious intersections with high traffic and good visibility. The building itself is generally quite cheap and less important.
These are very attractive characteristics that result in superior risk-adjusted returns. To make it clear, consider this comparison between an apartment community and a net lease property:
Let's look at an example:
Back when I worked in private equity, we would often target triple net lease properties that were leased to the grocer Aldi:
We would buy these at ~7% cap rates with 1-2% annual rent increases, no landlord responsibilities, and 10-20 year leases. We would finance half of the purchase with a 3-4% mortgage, which then resulted in a 10%+ cash-on-cash return from a bond-like investment with steady growth and inflation protection. Add to that the rent increases, and some cap rate compression, and the annual IRR landed in the 15-20% range.
Typically, you would need to accept significant risks to get such returns, but these are actually some of the safest investments that you can make, especially if you are well-diversified.
If you don't believe me, just take a look at the historic performance of well-diversified, professionally managed, triple net lease REITs that have existed for decades and went through many crises.
Realty Income (O) is the biggest and most popular.
It went public in 1994 and since then, it has compounded investor's capital at 15%+ year after year and has not missed a single dividend payment.
In fact, it hiked the dividend even in years 2000, 2008, 2009, and 2020:
That shows you that triple net lease properties are conservative investments that maintain their cash flow even during the worst of crises. And despite this low-risk profile, they can generate very lucrative returns to their owners.
This brings us to today.
Why Invest in Triple Net Lease REITs Today?
Like every investment, there are better and worse times to buy triple net lease properties, and today, we think that the time is very opportune.
This is because of a simple reason:
Triple net lease investments, and especially net lease REITs, offer significant upside potential as they reprice to the near-0% interest rate world we live in.
Typically, when interest rates decline, net lease REITs rise in value because all else held equal, lower interest rates result in lower cap rates, higher property prices, and lower interest expense - all of which justify a higher valuation.
But because of temporary covid fears, the repricing to higher levels is yet to happen in the net lease REIT sector. In fact, many of the highest quality net lease REITs are still priced at 15-20% below pre-crisis levels, and that's despite posting record-high cash flow and hiking dividends in 2020:
Before the pandemic - high-quality net lease REITs were priced at a 3.5% dividend yield when the 10-year treasury was at 2%. This means that the spread was roughly 1.5%.
Today, the 10-year Treasury is down to just 1.2%, and yet, many of these same REITs are now offered at 4.5%, 5%, or even more.
This means that the investment spreads are through the roof, and that's the opportunity.
As we move past the pandemic, and people slowly forget about it, we expect net lease REITs to reprice at a ~150 basis point spread over the 10-year Treasury. This means that they have 30-50% upside potential, in addition to the double-digit annual returns that we expect them to generate from dividend payments and cash flow growth.
Considering that these are retiree-friendly, conservative investments, we think that they present some of the best risk-to-reward in today's market, and for this reason, they are our largest investments at the moment.
What Are We Buying?
In total, we currently own 6 net lease REITs at High Yield Landlord. Each has unique pros and cons, and it is by combining them together that we get to properly capitalize on this opportunity.
Our single biggest position is still STORE Capital (STOR).
We first bought it at $15 per share at the onset of the crisis. Today, it already trades at $36, but we think that it is worth closer to $45 per share in today's yieldless world.
It is not the most opportunistic of its sector at the moment, but it still presents good risk-to-reward when considering that it is a blue-chip REIT.
While I am not anti-tech (or anti-crypto) by any means, it is quite ironic to see these investments being labeled as the "safe-haven" in today's market, when historically they would have been perceived as highly risky.
At the same time, triple net lease REITs, which are some of the world's safest investments, are priced as if they were highly speculative investments.
Once we put the pandemic behind, I expect the roles to reverse, and our triple net lease heavy portfolio to outperform.
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