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Everyone is feeling the pinch of inflation at the grocery store, the gas pump, and many other places. And landlords of all stripes are feeling it, too. But among them, net lease real estate investment trusts (REITs) have a business model with unique facets that help protect them against rising prices. And it is super easy for you to benefit right along with them, but only if you understand how net lease REITs can protect your real estate investments from the ravages of inflation. The one thing investors should do right now is to start investing in net lease REITs.
When you buy a building with the intent of renting out the space, you take on certain costs — building maintenance, property upkeep, and taxes, among many others. That’s true whether or not you own an apartment building, an office, or a store. On top of these costs, you have to find tenants and manage those business relationships.
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Right now, landlords’ costs are rising for everything from cleaning supplies to maintenance products to labor. Taxes are likely to head higher, too, as municipalities pass their own rising costs on. The only way they can offset those cost increases is by increasing the rent their tenants pay. That’s not as easy as it sounds, given that they will have to wait until the end of their lease terms to make those adjustments. And, of course, if they boost rents too much, tenants might decide to move out. The process of finding new renters has its own costs, not to mention the interim loss of rental income. So landlords may not be able to do as much as they’d like to offset those inflationary hits.
This is where the net lease model offers a distinct advantage. Under a net lease, the tenant is responsible for most of the operating costs of the asset they occupy. Usually, these are single-tenant properties, which can increase risk since a vacancy would mean zero income from the asset. However, with a large enough portfolio, that risk is manageable. The key here is that the tenant, who is responsible for most of the operating costs, is the one that has to deal with inflation’s impact on those costs. Meanwhile, net leases often come with long lease terms and have periodic rent increases built in.
A small investor looking to own a few properties won’t be able to get the kind of portfolio diversification necessary to offset the inherent risks of single-tenant properties. However, an entire class of REITs operates under the net lease model, making it simple to add this kind of inflation hedge to your investment portfolio. Here are three names worth looking at.
Realty Income (O -0.16%) is one of the largest players in the net lease space with over 11,000 properties spread primarily across the retail (78% of rents) and industrial (16%) categories. The REIT has increased its payout annually for 27 consecutive years, making it a Dividend Aristocrat, and for those looking for a steady income stream, it makes its distributions monthly. It has an investment-grade rated balance sheet and its average lease length is more than 10 years. Realty Income is something of a bellwether for the net lease space, so it tends to trade at a premium to its peers. However, for more conservative investors who are willing to pay up for quality, it could easily be a long-term holding. At today’s share price, the dividend yields around 4.2%.
If you prefer investments with more business diversification, then you should look at W.P. Carey (WPC -0.04%). This REIT was among the first companies to popularize the net lease sale/leaseback model and has been rewarding investors with annual dividend increases since its initial public offering in 1998. It’s well-diversified, with assets spread across the industrial (26%), warehouse (24%), office (19%), retail (18%), and self storage (5%) categories, among others. Around 63% of rents come from U.S. properties, with most of the rest coming from Europe. It is one of the most diversified net lease REITs you can buy, with more than 1,300 properties. (Office, industrial, and warehouse properties are generally larger than retail properties, which partially, though not fully, helps to explain why it has fewer assets than Realty Income.) The average lease length is over 10 years and, as an added inflation bonus, 58% of its leases have cost of living (essentially inflation) increases built in. At the current share price, its yield is around 5.1%.
Another option that investors might want to look at is relative newcomer STORE Capital (STOR -2.74%), which went public in late 2014. Focused on growth, it has already built up a sizable portfolio, with just under 3,000 properties in the fold. Roughly 80% of rents come from retail sites, the remainder from industrial. The average lease term is over 13 years and management prefers sale/leaseback deals so it can do deep dives into the finances of its potential tenants before it takes on a property. Notably, STORE Capital has increased its dividend each year since it came public, even during 2020’s pandemic-driven bear market, when many REITs cut their payouts. At today’s share price, STORE’s dividend yield is 5.6%.
Realty Income, W.P. Carey, and STORE are just three of the more prominent net lease REITs you might want to look at. There are a lot more to consider, including National Retail Properties (NNN -0.52%), another Dividend Aristocrat. The key today, however, is that the basic net lease business model that these REITs have successfully put into action limits the impact of inflation by design. If that sounds like a huge plus to you as you consider the rising costs you are facing with your real estate portfolio, then now’s the time for you to consider adding a few net lease REITs into the mix.
Reuben Gregg Brewer has positions in Realty Income and W. P. Carey. The Motley Fool has positions in and recommends STORE Capital. The Motley Fool has a disclosure policy.
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