Within the world of commercial real estate investment, there are a variety of vehicles through which individuals can invest in this asset class. Given the number of options, it is important to understand the nuances of each to ensure that they are a good fit for each investor’s risk tolerance and personal preferences. One of these vehicles that is popular with individual investors is known as a net lease REIT.
In this article, we will describe what a net lease REIT is, the pros and cons of investing in one, and how they compare to private equity investment options. By the end, readers will be able to make a direct comparison between net lease REITs and private equity deals to determine which one is a better fit for their needs.
At First National Realty Partners, we are a private equity firm who specializes in grocery store anchored retail properties, many of which contain net leases. To learn more about our current investment opportunities, click here.
What is a Net Lease REIT?
The term “net lease REIT” is a combination of a commercial real estate lease type and the vehicle through which properties with one can be acquired. To fully understand the term, it helps to break it into its parts.
What is a Net Lease?
A net lease is a commercial property lease type that requires tenants to pay a base monthly rental amount plus some portion of the property’s operating expenses. There are four types of net leases. They are:
- Single Net Lease: In a single net lease, the tenant pays base monthly rent plus their share of one of the property’s major expense categories, usually real estate taxes.
- Double Net Lease: In a double net lease, the tenant pays base monthly rent plus their share of two of the property’s major expense categories, usually property taxes and insurance.
- Triple Net Lease: The tenant pays base rent plus their share of three of the property’s major expense categories, usually real estate taxes, insurance, and maintenance.
- Absolute Net Lease: The tenant pays base monthly rent, plus all of the property’s operating expenses.
Of these four types, single tenant, triple net leased properties are particularly popular with individual investors. These are assets that have just one tenant, usually a high quality, national company like Walgreens or Starbucks, who occupies the property under a triple net lease structure. Because these types of properties can be very expensive, the best way for individual investors to gain exposure to them is through fractional ownership vehicles like REITs and private equity.
What is a REIT?
A real estate investment trust (REIT) is a real estate company that owns, operates, and/or finances commercial real estate assets. For the purposes of this article, the focus is on publicly traded REITs, which can be bought or sold on major stock exchanges.
Investors like publicly traded REITs for their liquidity, diversification, and tax benefits. But, they can be exposed to price volatility based on movements in the stock market and not any particular issue with the underlying real estate. It is important to note that REITs tend to specialize in specific property types. For example, two of the largest publicly traded REITs in the US – American Tower and Prologis – specialize in cell phone towers and warehouse/logistics facilities respectively. For the purposes of this article, the focus is on publicly traded REITs that specialize in “net leased” properties.
Net Lease REITs
As the name suggests, a net lease REIT is a REIT that specializes in the purchase and management of net leased properties. For real estate investors who like this structure, there are a number of net lease REITs to choose from. They include:
- Realty Income (Ticker: O): Owns ~6,750 net leased properties in the United States, Puerto Rico, and the UK.
- W.P. Carey (Ticker: WPC) Owns ~1,250 net leased properties across 25 countries
- National Retail Properties (Ticker: NNN): Owns ~3,150 properties across 48 states.
The exact structure of each portfolio varies by company, but they typically include single-tenant properties that are occupied by national companies. For example, the National Retail Properties portfolio includes retailers like 7-Eleven, Mister Car Wash, and Taco Bell. Because the portfolio can vary for each REIT, the performance can also vary.
Net Lease REIT Performance
REIT returns have two components, stock price appreciation and dividend income.
Stock price appreciation is driven by a variety of factors including: market sentiment, tenant occupancy, capitalization levels, leasing activity, portfolio performance, and tenant strength. Variations in these factors drive differences in REIT price performance. To illustrate this point, the following chart shows the return for each of the above three REITs over the past ten years:
Of the three, National Retail Properties provided the highest return from stock price appreciation only. But, this isn’t the only return component. One of the major benefits of investing in a REIT is that they are required to pay a high percentage of their income as dividends. So, when evaluating returns, it is also important to look at each company’s dividend yield.
Net Lease REIT Yield
IRS rules require REITs to pay 90% of their taxable income in the form of dividends. For this reason, they all have high dividend yields when compared to other companies. The dividend yields for each of the above REITs (as of this writing) are:
- Realty Income: 3.93%
- WP Carey: 5.42%
- National Retail Properties: 4.52%
Although National Retail Properties provided the highest return from a stock price standpoint, WP Carey has the highest dividend yield. So, it is possible that the total return for this REIT (price change + dividends) may actually be higher. The point is, Net Lease REIT performance shouldn’t be judged on stock price alone. Dividends are also a major component.
Advantages of Net Lease REITs
For commercial real estate investors, there are four advantages to investing in the publicly traded net lease REIT sector:
- Low Minimums: The minimum dollar amount required to invest in a net lease REIT is whatever it takes to purchase just one share. Often this can be as little as $50 or $100
- Liquidity: Shares in publicly traded REITs can be bought and sold at will, which provides a level of liquidity that is not available with other types of commercial real estate investments.
- Income: Because REITs are required to pay out a high percentage of their taxable income as dividends, investors benefit from a steady stream of passive income.
- Diversification: In the description above, each of the three REITs own thousands of properties. As a result, investors get a high level of diversification within each share purchased.
For these reasons, REITs are popular with individual investors who prioritize income and have a short to medium term time horizon (1-10 years).
Net Lease REITs vs. Private Equity Investments
A REIT is only one type of vehicle through which to invest in commercial real estate. Another popular option is to invest with a private equity firm, like ours. While the business model is the same – to use investor capital to purchase a diversified basket of commercial real estate assets, there are material differences between the two. Among the most important are:
- Legal: Private equity firms are not required to pay out a high percentage of their income as dividends. As such, they tend to provide a smaller cash flow stream, but…
- Returns: Instead, a larger component of private equity returns come directly from the property’s price appreciation. Over the long run, this can be more profitable for investors.
- Liquidity: By definition, “private” equity investments are not publicly traded. As a result, they are not as liquid as publicly traded REITs. Often, they require investment holding periods of 5-10 years, during which time an investor is not able to sell their stake.
- Deal Structure: Some private equity firms offer investments in a “fund” which is most similar to a REIT or ETF. Others – like us – offer investments in individual deals in the net lease sector, which allow investors to perform their own due diligence on the property and tenants.
When comparing net lease REITs and private equity investments, investors should research the specifics of each opportunity and choose the one that is the best fit for their own objectives.
Summary & Conclusion
A “net lease REIT” is a real estate investment trust that invests in net lease real estate. Individual assets are usually properties with high quality retail tenants on long term leases.
The performance of publicly traded net lease REITs is driven by two components, stock price change and dividends. For this reason, it is important for investors to look at both components to get a realistic picture of the potential total return.
For individual investors, the advantage of investing in publicly traded net lease REITs include: liquidity, low minimums, passive income, and diversification.
When comparing potential investment vehicles, REITs are often compared to private equity firms. Both companies have the same purpose – to deliver a return for investors – but the methods and strategies used to achieve this objective are very different.
Investors should review all aspects of each investment opportunity and choose the one that is the best fit for their own individual objectives.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.