Triple Net Leases Give Opportunity In Commercial Real Estate

Although the majority of commercial properties continue to struggle, triple-net leases continue to be the best performing sector of the commercial real estate marketplace and will likely continue to do so, with some generating as high as double digit annualized returns. 

In general, the commercial real estate sector has taken a devastating blow as a result of the global recession.  During 2007 though 2009, the sector as a whole witnessed prices fall by nearly 40 percent, as the sector is highly dependent on and driven by  a booming economy and job creation.  However, one sector in commercial real estate that didn’t fall as hard as the others was triple-net leases; they declined in value by nearly 15 percent during 2007-2009 (the S&P 500 dropped nearly 24 percent during the same time period).

Triple-net-leases are unique in that they are long-term leases in which tenants agree to take responsibility for maintenance, taxes and insurance- the three largest expenses of a rental property. From an investor’s perspective, they have appeal because they generate returns in two ways: through price appreciation and through income.  Additionally,

A common way to play the sector is through real estate investment trusts (REITs) which focus on triple-net leases.  One such REIT is Realty Income Corporation (O).  Not only does Realty Income Corp. have a relatively strong balance sheet, it has positioned itself well against its competitors as a result of its strong sale-leaseback underwriting in the retail industry.  Additionally, Realty Income is primarily involved in triple-net leases with tenants which results in 90%-plus EBITDA margins and healthy cash flows.  Lastly, Realty Income has continues to increase its dividends year over year for the past 13 years, even during the recession, which means that the REIT is generating positive cash flow and is expected to continue to do so.  O closed at $31.53 on Monday.

A second notable REIT emphasizing on triple-net leases is Ventas Inc. (VTR).  Ventas Inc. focuses on the health care industry, one that is virtually immune to a recession, and has witnessed a steady 60%-plus EBITDA margin as well as healthy cash flows due to the fact that triple-net-leases constitute for the vast majority of its net operating income.  Additionally, Ventas triple-net leases have built in rent escalators and are long-term in nature, minimizing some of the risks involved with REITs.  Lastly, the Louisville Kentucky based REIT recently raised its quarterly dividend by 4.4% indicating that it has plenty of cash on hand.  VTR closed at $47.41 on Monday.

Although these two REITs seem to show signs of prosperity in the near future, it is equally important to consider the risks that are involved with investing in them.   Some risks include lack of liquidity, high interest rates, inflation and increased taxes for commercial real estate investors.

To help mitigate these risks, an exit strategy which identifies specific price points at which an upward trend in the mentioned REITs could come to an end is of importance.

According to the latest data at www.SmartStops.net, these price points are: O at $30.51 and VTR at $43.67.  These price points fluctuate on a daily basis and are reflective of market volatility.  Updated data can be found at www.SmartStops.net.

Disclosure: No Positions

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