Everyone feels the pinch of inflation at the grocery store, at the gas pump and many other places. And owners of all persuasions are feeling it too. But among them, net lease real estate investment trusts (REITs) have a business model with unique facets that help them hedge against rising prices. And it’s very easy for you to profit with them, but only if you understand how net lease REITs can protect your real estate investments from the ravages of inflation. The only thing investors should do right now is start investing in net lease REITs.
The “normal” way of working
When you buy a building with the intention of renting the space, you incur certain costs – building upkeep, property upkeep, and taxes, among others. This is true whether or not you own an apartment building, an office or a store. In addition to these costs, you must find tenants and manage these business relationships.
Right now, homeowner costs are rising for everything from cleaning supplies to janitorial products to labor. Taxes are also expected to rise, as municipalities pass on their own rising costs. The only way for them to offset these cost increases is to increase the rent their tenants pay. It’s not as simple as it sounds, given that they will have to wait until the end of their lease to make these adjustments. And, of course, if they raise rents too much, tenants might decide to move out. The process of finding new tenants has its own costs, not to mention the intermediate loss of rental income. So owners may not be able to do as much as they would like to offset these inflationary blows.
A different way of doing things
This is where the net lease model offers a distinct advantage. Under a net lease, the lessee is responsible for most of the operating costs of the asset it occupies. Usually these are single-tenant properties, which can increase the risk since a vacancy would mean zero income from the asset. However, with a large enough portfolio, this risk is manageable. The key here is that the tenant, who is responsible for most of the operating costs, is the one who has to deal with the impact of inflation on those costs. Meanwhile, net leases often come with long rental terms and incorporate periodic rent increases.
A small investor looking to own a few properties will not be able to achieve the kind of portfolio diversification needed to offset the risks inherent in single-tenant properties. However, an entire class of REITs operate under the net rental model, which makes it simple to add this type of inflation hedge to your investment portfolio. Here are three names worth checking out.
“The Monthly Dividend Company”
Real estate income (O 1.09%) is one of the main players in terms of net leasable area with more than 11,000 properties divided mainly into the retail (78% of rents) and industrial (16%) categories. The REIT has increased its payouts every year for 27 consecutive years, making it a dividend aristocrat, and for those looking for a steady stream of income, it makes its distributions monthly. It has an investment grade rated balance sheet and its average lease term is over 10 years. Real estate income is somewhat of an indicator of net rental space, so it tends to trade at a higher price than its peers. However, for more conservative investors who are willing to pay for quality, it could easily be a long-term hold. At the current share price, the dividend yields around 4.2%.
Spread your bets around
If you prefer investments with greater business diversification, then you should consider WP Carey (WPC 0.59%). This REIT was among the first companies to popularize the net sale-leaseback model and has rewarded investors with annual dividend increases since its IPO in 1998. It is well-diversified, with assets spread across the industry ( 26%), warehouse (24%), office (19%), retail (18%) and self-storage (5%), among others. About 63% of rents come from US properties, with most of the rest coming from Europe. It’s one of the most diverse net leasehold REITs you can buy, with over 1,300 properties. (Office, industrial, and warehouse properties are generally larger than commercial properties, which partly, but not entirely, helps explain why they have fewer assets than Realty Income.) The average lease term is longer than 10 years and, as an additional inflation bonus, 58% of its leases include increases in the cost of living (essentially inflation). At the current share price, its yield is around 5.1%.
Another option investors might want to consider is the relative newcomer STORE Capital (STOCK 0.62%), which went public in late 2014. Focused on growth, it has already built up a sizeable portfolio, with just under 3,000 properties in the fold. About 80% of rents come from commercial sites, the rest from industrial sites. The average lease term is over 13 years and management prefers sale-leaseback agreements so they can thoroughly analyze their potential tenants’ finances before taking possession of a property. Notably, STORE Capital has increased its dividend every year since its IPO, even during the pandemic-induced bear market of 2020 when many REITs cut their payouts. At the current share price, STORE’s dividend yield is 5.6%.
Lots of options
Realty Income, WP Carey, and STORE are just three of the larger net rental REITs you might want to consider. There’s a lot more to consider, including Domestic commercial properties (NNN 0.55%), another dividend aristocrat. The key today, however, is that the core net rental business model these REITs have successfully implemented limits the impact of inflation by design. If that sounds like a huge plus when you consider the rising costs you face with your real estate portfolio, now is the time for you to consider adding some net lease REITs into the mix.