2024-01-01 19:46:55 ET
Summary
- Global Net Lease has struggled to deliver shareholder returns compared to competitors in the net lease space.
- GNL's cost of capital is significantly higher than competitors, making it difficult to identify and execute on accretive investments.
- W.P. Carey offers a better portfolio, growth profile, and financing opportunities, making it a superior option to GNL.
The most appropriate way to start this article is with a short review of real estate at the highest level. Real estate is a business with a beautifully simple model. Renting properties to tenants offers stable, predictable monthly income which is contractually bound for a period of time. To supplement this income is the appreciation of the underlying asset, driven by a combination of upward pressures such as inflation, improvements at the property level, and the growth of market rents. Historically, shorting REITs has been a dangerous business with very few successful examples worth noting.
Beneath the surface level are layers of complexity, specifically with publicly traded REITs. Running a successful real estate business goes beyond leasing to tenants and painting the walls. There are property management, asset management, capital markets, and other complex challenges, all of which will factor into the success of a public real estate company.
Today, we're going to take a look at a rare exception to the general success of REITs. Global Net Lease ( GNL ) is a net lease real estate investment trust with a storied past which has culminated in poor shareholder returns compared to competitors. Let's dive into GNL and explore the challenges that have faced this company and explain why the business has failed to deliver.
Who is Global Net Lease?
Global Net Lease is a net lease REIT with a diverse portfolio of net lease properties across the globe. Similar to other competitors in the net lease space, GNL focuses on “mission critical” assets. GNL explains that these mission critical assets are essential to the function of the underlying business. GNL recently acquired Necessity Retail REIT, which added to their multi-tenant retail portfolio. GNL says that nearly 60% of straight-line rent is derived from investment grade tenants. There is a massively important footnote beneath this metric. According to GNL, this estimate includes companies that have investment grade ratings from a firm such as Moody’s, as well as properties with an implied investment grade credit rating according to their internal credit model. This leaves room for interpretation as it is subject to the underwriting of GNL’s research team.
Source: GNL
GNL’s portfolio is strong and diverse with allocations across retail, office, and industrial spread across industries and geographies. The portfolio itself is comparable in terms of quality to other net lease REITs. So, here lies an important question. Why has Global Net Lease trailed competitors in the net lease space?
Strategy
Most net lease REITs operate under a model which combines internal growth and the acquisition of new properties to add size and diversity to the company. However, an important piece of an acquisition strategy is the potential for earnings accretion. If a REIT issues shares of stock to fund the acquisition of new properties and these properties deliver a return in excess of their cost of equity, it provides a positive impact to the underlying metrics of the stock. The cost of equity combined with the cost of a REIT’s debt forms the companies weighted average cost of capital or WACC. The WACC is a REIT’s compass in determining whether incoming investments are accretive.
Putting aside GNL’s recent merger with Necessity Retail REIT, GNL has a history of making aggressive acquisitions. The property profiles often align with top-tier players such as Realty Income ( O ) or W.P. Carey (WPC). For example, GNL currently has two deals in their pipeline as outlined in the third quarter investor presentation. The first asset being leased to FedEx in Illinois at a capitalization rate of 6.5%. The second is a portfolio of eight Dollar General assets at a 7.6% capitalization rate. Both deals align with the profile of an acquisition that would interest virtually any public net lease REIT investing in industrial or retail.
Source: GNL
However, the equity and debt being issued by Global Net Lease to finance these acquisitions is substantially more expensive than that of the aforementioned competitors.
This means that GNL is forced to either invest with substantially tighter (or even negative) spreads or seek acquisitions with a higher going in capitalization rate to compensate for the elevated cost of capital. According to the deals above, it is likely the former.
The company is taking steps to address these problems. However, this wraps GNL into a transformation story and management needs to reposition the portfolio to thrive. Some of these measures include internalizing management, strategic dispositions, and synergies realized through their recent merger. Even still, there is a superior option to GNL with a better track record and a fresh start for future growth.
The Alternative
W.P. Carey ( WPC ) has been the talk of the town for the past several months. For those unfamiliar, WPC is one of the oldest net lease REITs in existence today. The company touted an impressive track record which included earning dividend aristocrat status after more than 25 years of increased dividends. Shortly after becoming a dividend aristocrat, this record was tarnished as WPC announced the spin-off of their office portfolio into a separate public company called Net Lease Office Properties (NLOP). What caused more controversy than the spin-off, was the subtle announcement of a “dividend reset.” This “reset” meant WPC was no longer eligible for dividend aristocrat status. Given the focus on the dividend, this caused grief among investors who have since fled the stock. Although late to the game, the decision to exit office was appropriate and increased the quality of the underlying portfolio.
Prior to the spinoff, WPC owned a similar portfolio to GNL in terms of overall allocation. Today, the firm has eliminated its investment in office properties entirely, meaning it is composed of industrial and retail properties. Overall, WPC now offers exposure to a portfolio similar to GNL but without troubled office assets. Additionally, the lower payout ratio means a safer dividend and more cash held internally for new investment, capital improvements, or repayment of debt. After recently announcing the updated dividend, WPC trades with a similar yield pre-spinoff but with a better portfolio and more conservative payout ratio.
Conclusion
Investors are attracted to GNL by the common stock’s gratuitous yield. It's hard to ignore as it remains one of the few double-digit dividends available in the net lease sector. That said, the generous dividend has come at a substantial cost as the decline in the company's common equity has outweighed the delivery of a cash dividend to shareholders. While the company continues to take steps to improve their business and turn around, I see few reasons to own this company as it operates today. WPC offers a better portfolio, better growth profile, and better financing opportunities. Post spin-off, the company is well positioned to thrive and reinitiate their growth strategy around more attractive retail and industrial assets.
For further details see:
Why Global Net Lease Should Be Avoided And What To Buy Instead