O - Netstreit: 3 Reasons To Buy This REIT As Real Estate Rebounds

2024-01-04 10:53:02 ET

Summary

• Netstreit is a small-cap net lease REIT with a diverse portfolio of single-tenant retail assets.
• The company owns over 500 properties in 45 states, with more than two-thirds of annual base rent derived from investment-grade tenants.
• Netstreit's growth strategy, high-quality portfolio, and lack of refinancing obligations make it stand out in the crowded net lease REIT space.

Netstreit ( NTST ) is a small-cap net lease REIT with a high quality, diverse portfolio of single tenant retail assets. NTST launched in 2020 and has attracted attention in the net lease space with a portfolio of primarily investment grade rated tenants in essential industries. As illustrated below, the company owns over 500 properties in 45 states, leased to nearly 100 tenants. More than two thirds of annual base rent, or ABR, is derived from investment grade tenants.

Source: NTST

The net lease space is crowded with plenty of REITs competing for a limited pool of assets. Some of these are large, behemoth REITs with powerful track records, such as Realty Income ( O ) or W. P. Carey (WPC). Others have tried to replicate this success but have fallen short, such as Global Net Lease (GNL). The differentiating factors often lie in nuance and subtleties of REIT strategies. On a broad level, net lease REITs have performed well over time due to their simple business model. Without the complexities of development responsibilities, capital expenditures, and constant re-leasing, there are fewer variables in the machine.

NTST and other net lease REITs own property under a "triple net" lease structure. Triple net leases place three primary responsibilities upon the tenant. Property tax, insurance, and maintenance responsibilities are that of the tenant, leaving the landlord with little property level liability. In an inflationary environment, this will benefit net lease operators, as they will capitalize on rising rents but remain insulated from rising costs. Take this with a grain of salt as many so-called triple net leases leave the landlord with some property level expenses such as roof, structure, or parking lot maintenance. So why will NTST stand apart in a crowded room? There are three reasons to explore.

1. Growth

Growth is critical to the strategy of net lease REITs. Typically, net lease REITs have two mechanisms for growth. The first is the rent of escalators established under a lease. In the case of net lease REITs, these are typically 1.0%-3.0% per year or linked to CPI. Internal rent escalations offer limited room for real growth, given both styles of escalation remain modest over time. More importantly, net lease REITs can grow through the acquisition of new properties. Purchasing properties which return in excess of a REITs long term weighted average cost of capital, or WACC, offers the potential for earnings accretion. Growing AFFO per share is essential to supporting a growing dividend.

The perpetually low interest rate environment of the past decade was accommodating to this strategy, as rock bottom interest rate and favorable REIT valuations propelled significant forward motion for real estate as a sector. As a result, REITs, specifically in the net lease sector, have grown aggressively through new acquisitions and thrived as a result. That said, this has presented a problem for many operators such as Realty Income, who are becoming too large to sustain an acquisition-based growth strategy. Due to a smaller market capitalization, NTST does not need to acquire the same number of properties as larger REITs to continue growing, allowing NTST to be more selective with acquisitions. NTST continues to make acquisitions at a rate which can support a growth strategy, but at a modest rate compared to competitors such as ADC. Since IPO, NTST has sourced almost $1.5 billion in new acquisitions, compared to $4.8 billion for ADC over the same time frame. Compare this to the behemoth, O, who acquired/invested over $2.0 billion in the third quarter of 2023 alone.

Source: NTST

2. Portfolio Quality

NTST's selective acquisition strategy has allowed the company to maintain a high-quality portfolio. With nearly 70% of annual revenue being derived from investment grade tenants, the portfolio is strong from a credit perspective and aligned with other premier net lease operators.

Source: NTST

Beyond credit quality, the portfolio is also in a position to thrive with few leases expiring in the near term. With only 4.6% of ABR anticipated to rollover through 2026, NTST is well-positioned to thrive amongst any economic turmoil that may unfold. Since NTST is a newer REIT, the portfolio has fresher assets with newer leases. In contrast, O acquired its portfolio over more than five decades, meaning there are a variety of legacy assets and a constant stream of renegotiations with tenants.

Source: NTST

A high weighted average lease term, or WALT, and low rollover is typically a positive indicator for net lease REITs. While rollovers offer an opportunity to capitalize on market rent growth, working to lease properties and negotiate with tenants presents execution risk which relies on the experience and capability of management. Eliminating this risk factor offers one less opportunity for missteps.

3. Refinancing

NTST went public via IPO in 2020, meaning the firm has only existed for several years. As a result, NTST issues long term, unsecured debt which will have few refinancing responsibilities over the next several years. Over the past decade, low interest rates have encouraged REITs to issue debt and equity aggressively to fund growth strategies, even as cap rates declined across sectors. Rising interest rates have presented risks for operators as they must refinance at substantially higher interest rates, putting pressure on earnings and the actual spread of investments within the portfolio.

NTST is well insulated from this risk, with no debt maturities through 2027. Despite encouraging words that rate cuts are likely over the next twelve months, REITs are still refinancing their debt at substantially higher interest rates than just two years ago. This pressure will be significant as players in the space continue to refinance against the highest rates in years, however, NTST will remain unimpacted through 2027.

Source: NTST

This is perhaps the most significant advantage for NTST, as it offers an earnings boost in complete isolation relative to peers.

Conclusion

Net lease REITs are one of the best ways to invest in real estate. The business model is simple in both concept and execution. NTST operates in a crowded space and has yet to establish a track record. Trading at just 13.2x AFFO, the firm trades below the "blue chip" REITs such as ADC or O.

Source: NTST

Should NTST be able to maintain its strategy and stay the course, it is likely that more respect will follow. Personally, I believe NTST could be a potential buyout target for a larger REIT or a private fund, should the market conditions align appropriately in the future. For the time being, NTST has the recipe for success. The company has limited risks such as lease expirations or large refinancing obligations. At the least, NTST should continue to perform along with the net lease market, but I believe there is upside potential.

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