Net Lease Updates: Treasuries Driving Net Lease Lower
Net lease REITs were among the last equity REIT sectors to get pounded. It “could” be viewed as their high dividend yields making them more attractive relative to bonds. However, that argument falls apart when we look at the history. Net lease REITs are generally more sensitive to interest rates than other types of REITs.
We're focused on:
Realty Income (O)
National Retail Properties (NNN)
Agree Realty (ADC)
W.P. Carey (WPC)
Four Corners Property Trust (FCPT)
Spirit Realty (SRC)
Price Change Since April
I contrasted valuations on 10/02/2023 to valuations on 4/12/2023. Why 4/12/2023? Because that’s the date of our prior net lease REIT update. I wanted to assess how much of the swing in share prices was due to a swing in 10-year Treasury rates.
Old Rate: 3.39%
New Rate: 4.66% (as of 10/02/2023)
Note: Other Treasury durations (such as 2-year and 5-year) moved by a similar amount.
Here’s the change that actually happened, compared to the change implied by rates:
That’s remarkably accurate, isn’t it? You can adjust for WPC as being an outlier due to their stupid plan. Relative to the day before their announcement, they have dramatically underperformed the sector.
You may notice that the implied changes are much larger for some REITs than others. That’s one of the challenges with this method. It can result in really punishing REITs with lower yields and being more generous to those with higher yields.
Treasury to Net Lease Dividend Aristocrat Correlation
To find the correlation between Treasuries and net lease REITs, we want to focus on yields. I’m aware; this is probably the first time I’ve actually typed: “We want to focus on yields”.
We want REITs that fit certain criteria:
Steady dividend growth (no cuts, no 25% raises)
Regularly represents a large portion of “Analyst AFFO”.
Note: “Analyst AFFO” is similar to AFFO reported by many REITs, but it may require a couple of other adjustments to enhance quality. The adjustments are not relevant to this particular article.
Based on those criteria, Realty Income (O) and National Retail Properties (NNN) are great candidates. However, each has a drawback:
NNN: Concentration by property type (retail). Could distort results with concerns about retail specifically.
O: Dividend increase in February 2013 of nearly 20%. Distorts 2012 to 2013 trends by having a significant abrupt change.
I pulled the following metrics going back to at least late 2005:
Using the dividend history and the share prices, I calculated the forward dividend yield based on annualizing the most recent ex-dividend date. Could this be more precise by using announcement dates? Maybe. Could we use the actual forward growth to account for multiple raises in a year? Sure, but the magnitude of future raises is not known in advance.
Would those changes make a material difference? No. It would be a tiny difference, so we’re keeping it simple.
The following chart has three lines:
10-year Treasury Yield
O Dividend Yield
NNN Dividend Yield
You’ll notice there is clearly a very strong correlation. I’ve highlighted the two major macroeconomic events during that period and the part where O raised the dividend by nearly 20%:
Outside of the GFC (Great Financial Crisis) and the pandemic, correlations were generally pretty strong. That should create some concern for investors with the surge in rates.
It wasn’t a big issue for most of 2022, which was a bit surprising when other REITs began to get pounded. By late 2022, we can see one spike in all 3 lines.
I use this as one of my metrics for evaluating when I’m more or less interested in net lease REITs as a subsector. We can really highlight this with a fourth line:
O Minus Treasury (O’s dividend yield minus the 10-year Treasury yield)
In my opinion, this next chart is the heart of the article:
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