The pandemic has turned the commercial real estate world upside-down. Large, trophy assets like condo and office towers have seen a decline in investor interest and therefor value. At the same time, some of the smallest assets into its heaviest hitters. While practically every commercial sector suffers, single tenant triple net leases (STNL) are riding the strongest fundamentals in years. Much of what we now consider essential retail happens inside these often stand-alone storefronts, turning net lease REITs into unexpected dividend leaders.
Single tenant triple net leases have been dubbed ‘the real estate of America.’ A triple net lease (often written as NNN) is one where the tenant agrees to pay for rent and every other associated cost like taxes, insurance, and maintenance. The deals tend to offer lower rents as the tenant assumes most of the financial burden but this property type is considered one of the most passive types of commercial property ownership. All across the country, gas stations, pharmacies, coffee shops, grocery stores, and drive-thrus are all typically structured as an triple net.
It’s not just retail. While less visible, e-commerce distribution centers typically operate as triple net leases and can be some of the most lucrative. Each provides low-risk, steady income. In the tumultuous real estate market gripped by a pandemic, low-risk steady income sounds pretty good to investors.
Nine of the 52 equity REITs that paid higher total dividends in 2020 than they did in 2019 were net lease REITs, the single-highest total among individual property sectors. NETLease Corporate Real Estate ETF, a fund that specializes in net leases, was the 5th best-performing fund in the Morningstar Real Estate ETF Category in 2020, according to Seeking Alpha. The fund tracks the Fundamental Income Net Lease Real Estate Index, which in turn tracks the performance of the net lease real estate sector. The index shows net lease REITs have delivered average compound annual returns of 12.1 percent since the start of 2010, outperforming the high-profile NAREIT index, tracking practically every form of REIT. Net lease REITs have the fourth highest dividend growth rates, behind cannabis, cell towers, and single family rental REITs.
Net lease assets have performed so well because they’re full of essential businesses. By now we’re all familiar with life during the pandemic. You still have to shop for groceries, get your car fixed, fill prescriptions, stop for gas and pick up convenience store items. All that retail takes place at triple net lease locations. After initial lockdowns were lifted, net lease rent collection quickly recovered, now at roughly 96 percent, outperforming multi-tenant retail collections by nearly 20 percent. The problem is there just aren’t enough essential triple net properties to go around.
Safe, passive income from properties that don’t require much attention is just what investors want during uncertain times, creating immense demand for triple net properties. Political uncertainty surrounding infamous IRS 1031 exchanges, a favorite in the net lease world, created even more demand, as stakeholders rushed to get deals done while they could. With the supply of triple net leases limited going into 2020 and dim prospects of retailers expanding, red hot demand created a market imbalance owners have been surprisingly willing to sell into.
“The sellers who had the essential retailers, such as convenience stores and grocery stores, automotive parts and dollar stores, saw cap rate compression,” Anthony Pucciarello, Executive Vice President with Dallas-based Secure Net Lease, told Shopping Center Business Magazine. Pucciarello’s company sold $60 million worth of QuikTrip convenience store properties in 2020. “We could not keep a Jiffy Lube, 7-Eleven, QuikTrip, or Dollar General on the market for longer than a week.”
Unlike other forms of real estate, most triple net lease owners are not distressed. The assets aren’t in danger, the income is good and the investment hardly requires attention. Prices haven’t gone crazy either, properties are being traded at or slightly above asking price. Seemingly there’s little reason to sell, but a seller’s market is enticing many, fueling an asset class investors can’t get enough of.
For investors, the bodega down the street has become a blue chip investment, generating steady, predictable cash flow over long leases that can survive, even prosper during a pandemic. Long-term prospects for triple net assets also look good. Not only are triple net properties resilient in the face of lockdowns, they’re resilient against e-commerce. Essential retail can’t be replaced by Amazon, but there’s no way to deliver fresh tacos from an Amazon fulfillment center (yet).
These investments are not without their risks, mind you. Having one tennant means that vacancies essentially kill any cash flow the property has. But, when you look at the property type overall, the rewards have so far outweighed the risk. “Single-tenant net-lease assets sit at the crossroads of Main Street and Wall Street,” Mark West, Senior Managing Director, Capital Markets, JLL, said. “Investors are largely getting a hard asset and long-term, durable cash flow. As a general rule, net-lease properties provide a very good risk-adjusted return compared to a bond.”
Barring major changes to 1031 exchanges, the triple net lease sector looks to remain strong throughout 2021. Plenty of capital and strong fundamentals will keep both buyers and sellers active, further boosting net lease REITs and other investors specializing in the sector. A vaccine-backed recovery could put triple net tenants back in expansion mode, evening out the supply and demand imbalance. A rebounding national economy and return to the office could mean other real estate investment sectors return to form, stealing back the investor spotlight. But if we see more volatility for any reason, investors might want to double down on the properties that have the most reliable cash flow and many of those have triple net leases in place.