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STORE Capital Corporation (NYSE:STOR) is a single tenant, net lease REIT that develops, acquires, and manages retail properties across the United States. The firm distributes quarterly dividends and has increased the distribution annually since IPO in 2014.
Who is STORE Capital Corporation?
Store Capital Corporation is an internally managed, net lease real estate investment trust focused on single tenant retail properties. The firm touts itself as an industry leader in Single Tenant Operational Real Estate management, hence the acronym, STORE. Founded in 2014, STOR is one of the newest net lease REITs on the public markets. Despite lacking an established track record, STOR has quickly garnered a strong reputation in the sector, at least partially due to continued commitment from Warren Buffett.
Buffett first invested in STOR in June 2017 through the acquisition of 18.6 million shares via private placement. Buffett’s Berkshire Hathaway (BRK.B) added 5.8 million shares to the position during the depths of COVID-19 displaying substantial commitment to the business. Although the total investment is relatively insignificant for Berkshire Hathaway at under $1 billion, it is worth noting that STORE Capital is the firm’s only REIT investment. As of now, BRK owns just under 10% of STOR.
Real estate has always been a core component of Buffett’s investment thesis. Although direct REIT investments have not happened prior to STOR, Buffett has always expressed the necessity for income producing, productive assets, especially during inflationary periods. Buffett has touted real estate, agriculture, and manufacturing as some of the most protective businesses. The participation in rent collected through real estate or crops sold by farmland provide an inherent inflationary hedge as prices rise. STOR is a timely pick for Buffett as inflation continues to spook investors and threaten a prolonged period of limited movement in asset prices.
Source: Inflation Data
So, what makes STOR special enough to meet Buffett’s criteria? The answer lies in STOR’s highly productive assets.
The Portfolio
Source: STOR
As of today, STOR has built an impressive portfolio of net lease assets. The portfolio is widely diversified across tenants, industries, and geographies. The firm owns over 2,700 properties leased to 529 tenants in 49 states. The portfolio’s current occupancy rate is 99.6%, which is consistent with the firm’s history. Keep in mind, many of STOR’s initial leases have not expired given the firm is seven or eight years old. Occupancy rates could inevitably begin to deviate as leases begin rolling. The young firm has one of the best outlooks for rolling leases in the immediate term. Less than 5% of STOR’s portfolio is set to expire through 2025. Compare that to Realty Income (O) which will need to roll over 25% of the portfolio in the next four years.
Source: STOR
At first glance, STOR is similar to other familiar net lease competitors. Firms such as Realty Income, National Retail Properties (NNN), and Agree Realty (ADC) offer similar net lease exposure with wide diversification. It comes as no surprise that STOR’s performance has been consistent alongside the broader sector
However, STOR actually operates a distinct business model from competitors. However, the differences lie in nuance given each firm targets an overlapping portion of the net lease market, they remain important. STOR targets middle market tenants, placing a strong emphasis on corporate credit and the idea of “profit center” real estate. Realty Income places a strong focus on absolute credit, investing largely in Investment Grade clients in strong markets. National Retail focuses on “main street” real estate with a strong emphasis on fundamentals such as the ability to re-lease space.
Source: STOR
STOR’s high percentage of leases stemming from direct origination is evidence of a strategy which targets less established firms looking at financing through sale leaseback transactions. The portfolio is backed by an extremely high percentage of master leases at 94% of the total portfolio, increased over 2020 and 2019. By targeting middle market companies, STOR is able to sustain best in class acquisition cap rates. Don’t be misled by the claim that 72% of leases are held with investment grade tenants. STOR derives this metric from their internal rating system dubbed “STOR Score”. While this may be accurate, it certainly does not carry the significance of a credit rating from an established agency.
The proportion of investment contracts rated investment grade represents the percentage of our contracts (based on base rent and interest) that have a STORE Score that is investment grade; amount disclosed represents the average since the inception of the Company. We measure the credit quality of our portfolio on a contract-by-contract basis using the STORE Score, which is a proprietary risk measure reflective of both the credit risk of our tenants and the profitability of the operations at the properties
Source: STOR
Source: STOR
Direct origination and middle market tenants have led STOR to maintain a remaining weighted average lease term remaining of approximately 14 years, while still acquiring at cap rates which are substantially higher than competitors. While these cap rates come at the expense of absolute credit quality, the firm’s performance through COVID-19 speaks to strengths in internal underwriting and a successful overall strategy.
Has STOR’s strategy led to the outsized returns that the firm seeks?
Performance
STOR’s youth has allowed the firm to construct a portfolio from the ground up. As we displayed above, the firm has a longer weighted average lease term remaining than competitors and little exposure to rolling leases. In the short term, this leaves STOR protected from internal portfolio adversity. STOR has been able to maintain strong acquisitions over several years, including through the COVID-19 pandemic.
Source: STOR
However, as we recently highlighted with Gladstone Commercial Corporation (GOOD), acquisitions do not always translate to strong growth. REITs must acquire properties at capitalization rates which are accretive relative to their weighted average cost of capital. Successful spread investing is generally evidenced through growth in adjusted funds from operations or AFFO.
STOR has been successful through their impressive acquisition cap rates. Access to cheap debt and strong equity performance has led to a healthy financing environment. STORE has significantly outpaced competitors in terms of direct FFO per share growth. This fundamental metric displays the firm’s success relative to peers, however we must acknowledge that being a new firm makes growing easier.
FFO per share growth should translate to growth in the dividend given REITs must distribute 90% of taxable income to maintain their advantageous corporate tax structure. Once again, STOR has outperformed competitors and expectations, delivering strong dividend growth since inception. Unlike competitors such as O and ADC, STOR distributes income on a quarterly basis to investors. These dividends have increased annually since STOR’s inception. While it lacks the track record of a Dividend Aristocrat such as O, STOR is certainly on the right track as an income builder.
STOR’s combination of growth drivers has delivered a combined five year dividend growth which doubles Realty Income and National Retail Properties. With an inflationary environment, STOR’s 6.4% compound annual dividend growth rate offers the most significant spread over the current rate of inflation. When combined with STOR’s current yield of 4.49%, the growth offers a meaningful driver of total return.
We have outlined that STOR has the right recipe to operate a highly successful business model. At this point, we must dig in and see if the firm has delivered its value as a driver of total return to investors. Delivering strong dividend and share price performance, STOR has outpaced the Vanguard Real Estate ETF (VNQ) as well as its blue chip competitor, O since IPO.
Given STOR’s focus on middle market credit profiles, the outperformance is a welcome compensation for the added risks. STOR has successfully navigated challenges over the past two years, strengthening our trust in both management and the business model. Having established STOR’s successful track record, does the current outlook position the firm for further success?
Outlook
Investors in net lease REITs were rightfully worried as the world was gripped by the pandemic. Rent collection dramatically declined across the sector as tenants refused rent payments, hoping a legal argument would follow. Investment volumes also declined as is no surprise. However, the rebound in the sector has surprised all but the most optimistic investors. Following four consecutive quarters of decline, the retail sector has rebounded dramatically. According to CBRE, investment volumes in the retail sector have jumped to the third highest quarter on record in the second quarter of this year. This market strength should position STOR to continue acquiring at strong volumes. Additionally, liquidity in the middle market has been fostered by generous monetary policy implemented by the government. As a result, credit profiles have been maintained thus supporting capital markets access and financing through sale leasebacks.
Having witnessed a fast paced and substantial recovery in the broader market, STOR’s outlook remains strong. We have recently covered a variety of REITs, often focusing on similar risks. At this point, rising interest rates have the potential for meaningful disruption as financing costs increase. Being that REITs operate by investing for spreads over their cost of capital, an increase in financing costs will directly pressure results. As we have previously discussed, sector wide challenges such as rising rates will more heavily impact REITs on the lower end of the totem pole, such as GOOD. Meanwhile, STOR’s focus on high acquisition cap rates will help the firm maintain a positive spread, should financing costs increase. However, data also shows interest rate risk may be overblown as it relates to real estate.
According to S&P Global, REITs have been able to survive and outperform rising rate periods due to other macro-economic factors that often accompany a rising rate environment. For example, rising rates have historically been associated with inflation, a strong tailwind for real asset values.
Source: S&P Global
While we cannot be certain about the future, we believe well capitalized firms maintain the best outlook in a difficult macro environment. STOR’s conservative capitalization and long standing leases will create stability during periods of uncertainty. Furthermore, the focus on “profit center” real estate could benefit the firm. STOR invests in assets which are highly profitable or essential to the tenant’s operations. The though process is centered on the concept that the best performing locations maintain resilience even among lower quality tenants. With a 99.6% occupancy rate post pandemic, the strategy has some merit.
Conclusion
While time will unveil the overall outlook, STOR is well positioned among competitors. Outperforming peers since their IPO, STOR has assembled a strong portfolio with close tenant relationships. STOR’s strategy has led the firm to cast a wide net. The firm has accepted more credit risk, relying on internal credit analysis and mission critical real estate to protect itself. Fueled by an advantageous financing environment and a strengthening net lease market, STOR has captured sector upsides and has outperformed peers with a best in class distribution. All in all, it makes sense why STOR became a Buffett pick.
