This dividend aristocrat REIT has never closed a single deal with its largest tenant
Domestic commercial properties (NYSE: NNN) is a veteran in the net rental real estate industry, with an impressive streak of 33 consecutive annual dividend increases under its belt. This makes him a dividend aristocrat.
Here’s the thing: you don’t hit a record like that by accident, and the proof of that is a weird little quirk about the real estate investment trust’s (REIT) portfolio – it never signed an agreement with its largest tenant, 7-Eleven. Here’s why you should care.
A unique approach
The first thing to note about National Retail Properties is that it owns single-tenant properties where its tenants are responsible for most of the operating costs of the assets they occupy. This is called a net lease. Any individual property has a significant risk associated with a vacancy, as there is only one tenant. However, spread over a large portfolio, this is a very low risk way for a REIT to operate. National Retail Properties owns nearly 3,200 properties.
Many REITs use the net lease approach, so it’s not that unique. However, there are other factors that set this Dividend Aristocrat apart. For starters, it focuses exclusively on commercial properties. And when he reviews these properties, he tries to buy a specific type of asset, favoring locations that are suitable for the current tenant and could easily be re-let to another. This includes modest current rents that are easy for tenants to pay, as well as locations on busy roads.
How does the REIT know it is on the right track? The first big indication is that between 2007 and 2021, just over 70% of its sale-leaseback deals came from customers it was already doing business with. And, just as interestingly, the average cap rate on those trades was 7.6%, compared to the rest of his purchases, which averaged around 7.4%. Clearly, National Retail Properties customers see value in what it offers.
But there is another factor worth considering here. In addition to paying particular attention to the properties it buys, National Retail Properties also makes sure to work with a particular type of tenant. It favors “selective lower-quality tenants” over higher-quality tenants. Why? For starters, he can charge them more rent. However, there is also an opportunity for credit enhancement through operator mergers and acquisitions.
Basically, if he chooses good companies to work with, those companies could be taken over by even better ones. These types of transactions improve the overall quality of the portfolio for the REIT and its investors. And due to the relational nature of National Retail’s sale-leaseback agreements, it typically selects the best properties. These are exactly the ones that are most likely to stay open after a tenant buyout. But how much of a problem is that?
On National Retail Properties’ third quarter 2021 earnings conference call, in response to an analyst question, Chief Executive Julian Whitehurst said:
…you mentioned 7-Eleven as our top tenant. We have not done any business directly with 7-Eleven. All of our exposure to 7-Eleven in the portfolio is – was originally from the transactions we made with strong regional operators that grew and were eventually acquired by 7-Eleven in one way or another . And to the extent that we have other operators that will also be acquired by 7-Eleven in the future – I don’t know, that will happen one day. But if that happened, 7-Eleven would become an even bigger tenant of ours, but we wouldn’t worry about that. We’re keeping an eye on it, but we wouldn’t lose any sleep over it. That – our 7-Eleven real estate is some of our best real estate at some of our best prices and yields of anything in the portfolio.
The company’s exposure to 7-Eleven amounts to 139 properties and represents 4.9% of rents. While this is not a worrying number, it is not a small number either.
Essentially, there are two big takeaways. You know you have a good business model when your customers want to continue doing business with you. But you know it’s a really good model when working with tenants who get swallowed up by one of the biggest and best operators in the convenience store industry — with such frequency that the acquirer is your biggest tenant, even if you never bought a single property from them. And, in particular, these locations generally remain open.
Differentiated by design
National Retail Properties typically trades at a premium, providing a return similar to the industry leader in net rental Real estate income, which has a different business approach. That said, National Retail Properties’ consistent and successful business model is one of the main reasons for the premium it is generally given.
However, following the pandemic slowdown in 2020, National Retail Properties’ yield is now 4.8%, compared to Realty Income’s 4.3%. There could be an opportunity for long-term investors here, assuming the continued success of National Retail Properties eventually narrows this gap again.
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Reuben Gregg Brewer owns Realty Income. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.