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The Little-Known Secret
to Successful Real Estate Investing:
Triple Net Leases
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Published:
October 6, 2008
The housing crisis has derailed
stock markets around the world, but
there's one corner of the real
estate market that has been largely
spared -- real estate investment
trusts (REITs) with tenants under
long-term leases known as "triple
net" leases.
Over the past year, the shares of
select REITs holding these long-term
leases have gained an average +8.2%,
strongly outperforming the S&P 500's
-19.2% and even outpacing their
peers as represented by the MSCI
U.S. REIT Index's -12.5% 1-year
return.
And since these special leases
usually have a built-in rental
increase clause, the REITs that hold
them are dividend growth machines
that pass along the rising income
stream to shareholders.
In fact, many triple net lease
trusts have raised their dividends
in the last four quarters -- a
remarkable feat at a time when the
ratio of companies cutting payouts
to those raising them is the highest
in 17 years, according to Standard &
Poor's data.
What Exactly is a Triple Net
Lease?
A triple net lease (sometimes
referred to as NNN) is generally a
long-term contract of 20 years or
more, where the tenant pays property
taxes, building insurance, and
maintenance expenses in addition to
rent. The lease is so-called because
the rent is paid after (or net of)
these three types of expenses.
Triple net leases are the creme de
la creme of lease arrangements,
especially when they're made with a
single tenant carrying a quality
credit rating. Less common are
"double net leases," where the
tenant covers only taxes and
insurance and "single net leases,"
where the tenant only pays property
tax in addition to rent. In
contrast, "gross leases" are where
the tenant pays rent and the
landlord pays all expenses.
Triple net leases are often the
result of a real estate sale and
leaseback arrangement. A retailer
like Home Depot (NYSE: HD), which
both owns and occupies its own
locations sells the property to a
REIT or other investor. It sweetens
the sale by agreeing to a long-term
lease with the REIT on a triple net
lease basis.
It's a win-win deal -- the company
gets cash up front while the REIT
and its shareholders get a
predictable income stream.
For example, Omega Healthcare (NYSE:
OHI) specializes in sales/leaseback
arrangements. It buys properties
owned by healthcare providers and
then turns around and leases them
back to those companies. That frees
the healthcare providers from the
hassles of managing real estate
while also allowing them to monetize
their asset. Meanwhile, the
arrangement gives REITs like Omega a
reliable rental stream, which
generates solid investment returns.
Although rents do tend to be lower
in triple net leases, expenses are
also lower, and many of the
arrangements also call for annual
rental increases as a hedge against
inflation. Another benefit of triple
net leases is they generally allow a
REIT to establish a line of credit
on more favorable terms since they
are backed by secure earnings.
Most triple net leases are held by
healthcare and other REITs that
operate out of single-tenant,
free-standing buildings. The
downside to these single-tenant
leases is the risk that the tenant
runs into trouble and can no longer
afford to pay the rent. However,
these REITs typically hold a diverse
portfolio of real estate assets that
limits their exposure to any one
tenant. Omega, for instance, owns
some 240 healthcare facilities
operated by dozens of different
providers in 30 states across the
U.S.
Finding REITs with triple net leases
is a key to successful REIT
investing, but the information is
sometimes a little hard to
come by. But with a little digging,
High-Yield Investing Editor Carla Pasternak uncovered about two
dozen REITs that specialize in the
strategy in a recent issue. She whittled down her list to
only those high-yield REITs with
yields of at least 6%, which have
proven their ability to weather a
tough real estate market by growing
their dividend within the past 12
months.
She raised the bar even
higher and eliminated any REITs
which didn't have share price
returns that surpassed the broader
S&P 500 over the past year. If
you want to see Carla's list of
REITS that measured
up on all these strict criteria
-- and
had
average gains of nearly +10% over
the past year while offering
dividend yields of up to 6.6% -- or
you'd like to learn more about High-Yield Investing,
please visit this link. |
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