Why This REIT Will Thrive During a Recession
With the Federal Reserve strongly suggesting raising federal funds rates several times this year, investor fears of a possible recession have risen accordingly. In the first quarter of this year, gross domestic product (GDP) fell at an annualized rate of 6.5%. According to the Atlanta Fed’s GDPNow index, GDP growth in the second quarter is expected to be less than 1%. If we have negative GDP growth in the second quarter, some analysts consider this to be a significant (but unofficial) indication that the US is in a recession.
During recessions, stocks with defensive characteristics tend to outperform. STORE Capital (STOCK -0.74%) is a real estate investment trust (REIT) with highly defensive characteristics that also offers an attractive yield. Here’s why it should thrive in a recessionary environment.
The Secret to Sole Tenant Operational Real Estate Success
STORE is an acronym that stands for Single Tenant Operational Real Estate. The company develops stand-alone properties and rents them to tenants under long-term leases that require the tenant to absorb most of the costs, including taxes, maintenance and insurance. These leases are commonly referred to as “triple net” leases, and they are different from the typical gross lease, in which the tenant pays the rent and the landlord handles the maintenance, insurance, and taxes.
Tenants generally choose between outright ownership or renting. Leasing is an attractive proposition for a business that wants flexibility. Long-term triple net leases generally contain fewer covenants than bank loans and are easier to unwind if the tenant chooses to leave. STORE generally buys the property from the tenant and then leases it, which is called a “sale-and-leaseback” transaction. STORE Capital often has the ability to borrow at a lower rate than the original tenant, which in part explains its value proposition to its tenants.
A largely defensive tenant base
STORE Capital’s tenant base is concentrated in businesses that are largely unresponsive to the state of the economy. Restaurants (fast food and full service) are the largest category with 12% of revenue, followed by preschools, auto repair and health clubs. It also leases space to manufacturers and retailers, particularly farm and ranch stores. These companies will generally outperform cyclical stocks during a recession. People will continue to hit the gym, buy gas, buy groceries, and need their oil changed. Mall REITs, which house many fashion stores, will be more at risk.
STORE has outperformed most REITs during the pandemic
Unlike most REITs, STORE Capital has been able to weather the COVID-19 pandemic without cutting its dividend. This is because the company’s funds from operations (FFO) have increased in 2020 and 2021. FFOs are typically used for REITs because amortization is a significant expense that is deducted from net income under generally accepted accounting principles. (GAAP). That said, depreciation and amortization are non-cash expenses, meaning the business doesn’t write checks, so cash income is higher than net income would suggest.
Most of STORE Capital’s debt is fixed rate, so the current rise in interest rates will only have a moderate effect on the company’s earnings going forward. At current levels, the stock has a dividend yield of 5.8%, which is quite attractive. The company has increased its dividend every year since 2015. If STORE Capital has been able to navigate the COVID-19 pandemic and increase FFO and dividends, it should be able to weather any downturns to come.