National Retail Properties, Inc. (NNN) is a publicly owned equity real estate investment trust. The firm acquires, owns, manages, and develops retail properties in the United States.
Last week, National Retail Properties raised its dividend by 4.40% to 47.50 cents/share. This marked the 28th consecutive year of annual dividend increases for this dividend champion. This is an impressive track record that is a testament to the stability and defensibility of the company’s business model. National Retail Properties is one of only four publicly traded REITs and 94 publicly traded companies in America to have increased annual dividends for 28 or more consecutive years.
National Retail Properties has managed to raise dividends at a rate of 3%/year over the past decade. Unlike many other REITs that cut distributions during the Global Financial Crisis however, this blue chip REIT managed to grow the dividend no matter what.
The annual dividend rose from $1.40/share in 2007 to $1.78/share in 2016. I like the slow and steady approach to growing the distribution to shareholders over time. This is one of the guidelines I look for when evaluating real estate investment trusts.
Over the past decade, National Retail Properties has managed to boost its FFO/share from $1.94 in 2007 to $2.28 in 2016. This is a rather slow rate of FFO growth, which is mostly a result of the conservative nature of the REITs management team. They focus more on the fact that their shareholders rely on the dividend, which is why paying dependable dividends is a higher priority than growing that dividend at any rate.
Future dividend growth will be generated from acquisitions of new properties, growth in organic rental income to name a few factors. When you invest in properties with a cap rate of 7%, and your cost of capital is 4% - 5%, you grow funds from operations over time. When those properties increase rent revenue through regular annual escalation clauses, that adds further to funds available to pay for higher dividends too.
The triple net business model essentially allows this REIT to get into long-term lease agreements with tenants, with lease escalation clauses that protect rental income from inflation. The commercial tenants are typically responsible for paying rent, utilities, taxes and capital expenditures on properties they leased from National Retail Properties. Right now the weighted average remaining lease term is over eleven years. Only a small portion of leases will expire by the end of the decade, and roughly 60% of leases will expire almost a decade from now. This dependability in future revenue bodes well for the REITs ability to pay future dividends that are dependable.
The FFO payout ratio has only increased from 72% in 2007 to 78% in 2016. However, this ratio increased above 100% during the crisis. Yet, management didn’t cut distributions, which was exemplary behavior for them to follow. I generally like to have a good margin of safety in dividend coverage. I believe that the dividend payment is well covered, and well supported by the repeatable nature of rent income that this REIT generates.
The portfolio has had a high occupancy rate over the past decade. It never fell below 96%. Currently, the portfolio occupancy rate is slightly above 99%.
I find it helpful to look at tenant concentration. When comparing to Realty Income, which is the golden standard for Triple-Net-Lease REITs, I find that some of the tenants are a little higher risk of being unable to continue their long-term leases. If a tenant is unable to pay rent and goes bust, not all is lost of course. The landlord can always repurpose the property and lease it to another tenant. They can always sell a property as well, and allocate proceeds elsewhere.
The REIT has found that having well-selected retail tenants provides a stronger performance through various economic cycles than office, industrial or other tenant types. Its high trafficked locations provide strong market for replacement tenants and rent growth.
NNN's management team has a strong retail expertise in evaluating locations. But if a larger portion of those retailers have problems staying in business, this is a potential risk factor to be aware of.
I believe that the dividend is stable, however I also know that the risk with this REIT could be the revaluation of share prices if interest rates obtained by investors rose from here. For example, if 10 year Treasuries provide a 4% yield, the cost of capital for National Retail Properties will be higher, and the shares may sell at a dividend yield of 6% - 7%. Higher cost of capital may depress future growth rates, refinancing existing debt obligations may get more expensive, which may eat into FFO growth. Right now the debt is staggered to mature between 2021 and 2026, and has a relatively low interest rate.
On the plus side, the company has a low leverage balance sheet, and relies on debt for only a portion of its financing needs. The well laddered nature of debt will absorb spikes in interest rates in individual years. The REIT has traditionally relied more on equity for its financing needs, which is a double edged sword however, since it dilutes existing owners.
This Real Estate Investment Trust will not make you rich. However, if you are looking for mostly high current income it may be a decent holding in a diversified portfolio. The future expected returns on this REIT will likely be around in the 8% range over the next decade (5% yield plus 3% dividend growth). In terms of valuation, I would be interested on this REIT when it yields at least 5%. At the current annual dividend rate of $1.90/share, this is equivalent to an entry price below $38/share. An alternative could be selling a put in order to obtain the desired entry price. Due to lower liquidity however, bid/ask spreads would be wide however.
Full Disclosure: Long O and NNN
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Article by Dividend Growth Investor