Streetwise

Lauren Rudd

Sunday, October 14, 2012

The World of REITs

The financial markets are buffeted by events in much the same way that a sailboat finds itself at the mercy of the wind. Moreover, the waves of volatility often reach dramatic proportions. Such is the nature of the beast. So it is not surprising that the oscillation between anticipation and disappointment over the current economic outlook, both domestically and globally, is roiling the investment waters.

Nonetheless, Wall Street still offers up the greatest potential for accumulating wealth. Yet the days of buy and hold with unremitting patience are long gone. The decision to sell is as important as deciding what and when to buy.

So where do you begin? One possibility might be to consider National Retail Properties (NNN), a company whose year-over-year total return is 25.48 percent and one of only four publicly-traded REITs and 104 publicly traded companies in America to have increased dividends for at least 23 consecutive years.

The company has a market cap of around $3.367 billion making the Orlando-based REIT the second largest single tenant REIT nationally with a uniformity of performance that is nothing short of remarkable. At the same time evaluating a REIT is a bit different other corporate evaluation formats.

In lieu of earnings per share you use a metric called Funds from Operations (FFO) and Adjusted Funds from Operations (AFFO) when analyzing a REIT’s cash flow from operations.

FFO is defined by the National Association of Real Estate Investment Trusts (NAREIT) as net income less gains or losses from property sales plus depreciation of real estate and amortization of capital expenditures. AFFO goes a step further and subtracts routine expenditures that are required to maintain a portfolio of properties.

For the quarter ending June 30, National Retail posted FFO of $0.41 per share as compared to $0.38 for the same period a year prior. The Company’s success is attributable in part to its attention to three key areas: managing risk through careful underwriting, by diversification of its portfolio of holdings and by employing modest levels of unsecured debt on its balance sheet.

National Retail’s moderate debt level, the debt-to-total assets ratio is currently about 35 percent, and a portfolio of laddered debt maturities, work in tandem to insure against a time when capital is not plentiful or well-priced. Furthermore, by utilizing unsecured debt, instead of secured mortgages, the Company has considerable flexibility in managing both its portfolio of properties and the terms of its leases. Specifically, the Company can modify either in response to tenant needs. It can even sell properties, all without the consent of a lender.

Meanwhile, with returns well above the Company’s cost of capital, there is an on-going consistency in dividend growth and the growth of total returns, both of which have exceeded industry averages for the past two decades. Additionally, the Company can provide those who are selling properties with certainty of execution because acquisitions are not subject to the restrictions of obtaining a mortgage.

The Company’s latest guidance suggests an acquisition volume going forward of approximately $400 million. However, acquisition volume is only part of the equation for growing bottom-line results. The return on those assets, the quality of the locations and the tenants, and the terms of the lease agreement are also key.

An advantage held by National Retail is that the majority of its properties are relatively small, often purchased for between two and four million dollars. At the same time the universe of single tenant, freestanding retail properties is large with relatively little competition from other buyers. Additionally, the more granular small asset size enables increased diversification, thereby further mitigating risk.