The Paradox Of Net Lease REITs

Sep. 23, 2022 5:38 AM ETNETL
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Summary

  • Net lease as a sector remains attractive, despite outperforming U.S. REITs by nearly 1100bps as of 9/15/2022.
  • Recently STORE Capital Corp, a $14 billion net lease company, announced an agreement to be taken private in an all-cash deal by GIC (Singapore’s Sovereign Wealth fund) and Blue Owl Capital’s Oak Street.
  • The net lease subsector offers an opportunity to benefit from necessity based and post-pandemic demand drivers at a safe distance despite rising rates.

Real estate investment trust REIT. Finacial concept 2022

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By Archena Alagappan

The net lease subsector offers an opportunity to benefit from necessity based and post-pandemic demand drivers at a safe distance despite rising rates, at relatively attractive valuations.

When interest rates rise, net lease REITs can appear to be less desirable for their long lease durations and limited escalators. Higher interest rates often make net lease companies look expensive, given reduced acquisition spreads. However, net lease as a sector remains attractive, despite outperforming U.S. REITs by nearly 1100bps as of 9/15/2022.

U.S. Inflation is proving to be more stubborn and widespread. While some drivers of inflation are fading, consumer spending on services—which represents two-thirds of overall spending and are not being captured by retail reports—continues to be strong. For example, restaurant traffic has surpassed pre-pandemic levels, despite prices rising 8% over the last year. This has resulted in an environment where net lease real estate has the potential to offer the best of both worlds: long leases with dependable revenue streams in an inflationary environment that typically hurts discretionary spending.

Private equity fundraising has been robust until recently. There is still abundant capital on the sidelines and investors are looking to deploy it, albeit in relatively safer assets. Real estate has tended to be an attractive hedge against economic uncertainty and inflation, often providing safe and stable rental streams with demand drivers that resonate in a changing world. Recently STORE Capital Corp (STOR), a $14 billion net lease company, announced an agreement to be taken private in an all-cash deal by GIC (Singapore’s Sovereign Wealth fund) and Blue Owl Capital’s (OWL) Oak Street. While the timing of this deal surprised us, the rationale of the deal resonated given the attractiveness of the net lease subsector with attractive dividend yields and solid balance sheet strength.

We believe public REITs can offer attractive opportunities to invest over the longer term - they generally have strong balance sheets, improved asset quality and diverse tenants. During times of uncertainty, public market liquidity have tended to result in increasing volatility of share prices, despite unchanged rental streams – we estimate U.S. REITs are trading at a 20% discount to NAV on average. We have seen this result in private equity and sovereign wealth funds looking to acquire discounted public REITs - to acquire quality real estate at scale and grow stable revenue streams on a levered basis.

The net lease subsector offers an opportunity to benefit from necessity based and post-pandemic demand drivers at a safe distance despite rising rates.

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