Build a Powerful Platform with Triple-Net REITs

NEW YORK (TheStreet) -- The attraction of an income-producing property is that an investor can own a sustainable revenue stream by renting the asset to a strong tenant. To achieve the highest return on that investment, most people insist that a professional manager help collect rents, manage the property and market it -- all of which eats away a substantial portion of the profits.

One asset class that provides the least risk and least management responsibilities is the single-tenant net-leased category, often referred to as the "triple-net sector." Unlike other asset types, the triple-net investor can sleep well at night knowing this low-risk alternative offers a margin of safety unlike any other.

Triple-net properties offer a well-balanced investment alternative whereby the underlying asset value is supported by three primary components. Somewhat like the three legs to a stool, these components enable the investor to achieve less volatility and increased stability.

This first component, or leg to the stool, is credit. Many triple-net tenants lease prototypical facilities in order to gain a competitive advantage in the marketplace.

For example, the top-dollar store chains like Dollar General ( DG) and Family Dollar ( FDO) are located on primary intersections with traffic adequate for the tenant's business model. Many triple-net tenants utilize lease structures in order to leverage the company's balance sheet with minimum corporate cash invested.

The tenant's balance sheet and credit rating are an important component to the sleep-well-at-night strategy. However, there are two other important legs to the investment stool. In order to balance the asset choice, the investor should also consider the underlying lease structures.

The second important component is the lease term. Most triple-net leases are for between 10 and 25 years. As a comparison, hotels typically lease by the day, mini-storage by the month and apartments by the year. With a long-term lease in hand, triple-net investors spend considerably less time managing and marketing than owners of other asset classes.

The third leg to the stool is rental increases. Most triple-net properties have rental increases during the base-lease term, while many of the other asset classes have rental increases that are determined by current market conditions.

For example, hotel, multi-family and mini-storage rents are determined by a variety of factors, including supply and demand. Many of these operators have had to decrease rents in order to stabilize occupancy rates and to meet debt-service and operating-expense requirements. However, most triple-net properties provide for fixed rental increases, and some include percentage-of-sales multipliers. Having growth and income incorporated into a sustainable revenue stream makes the triple-net sector a very appealing alternative.

So with a well-balanced investment strategy, triple-net investors seek a fundamentally safe, low-risk strategy where principal preservation and sustainable income -- and growth -- are a must. Essentially, the triple-net investor is seeking a bond-like investment in a real estate wrapper.

While you could invest in Wallgreen ( WAG) stock, which is paying around a 1.1% dividend yield, you could, instead, acquire a triple-net property leased to Walgreen. The latter would provide more security than the stock, while achieving an unleveraged return of approximately 6% to 6.5%. Most Walgreen leases are 25 years, excluding options, with minimal management responsibilities, making this type of investment comparable to a bond.

The Triple-Net REITs

There are five triple-net REITs in the FTSE NAREIT Index with a combined market capitalization of $11.281 billion as of July 31. The retail sub-sector has produced an average year-to-date total return of 18.24% and has an average dividend yield of 4.28%.

These five triple-net REITs -- Realty Income ( O), National Retail Properties ( NNN), American Realty Capital Trust ( ARCT), Agree Realty Corporation ( ADC), and American Realty Capital Properties ( ARCP) -- are all worth considering, as they are supported by a common value proposition of durability and sustainability.

The essence of an intelligent investment strategy is to build a portfolio around lasting differentiation. By providing a well-balanced platform supported by credit, income and growth, triple-net properties provide for a powerfully repeatable fixed-income alternative with differentiated characteristics.

Ben Graham, author of The Intelligent Investor, wrote: "It is the consistency in the products that creates consistency in a company's profits. Consistency and durability are attributes for competitive advantage."

Repeatability is the essence of the triple-net investment strategy and also the prime source of competitive advantage. Triple-net REITs offer transparency, liquidity and sustainability. Because of these balanced attributes, investors should consider what Albert Einstein called "the most powerful force in the universe": the power of compounding.

At the time of publication, the author had no positions in any of the investments mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Brad Thomas researches and writes on a variety of real estate based fixed-income alternatives including both publicly traded and non-traded REITs. His focus is on equity REITs where he writes weekly articles for TheStreet, Forbes.com, and Seeking Alpha. He also is a Senior Vice President at Bull Realty, of Atlanta, Ga., where he focuses on triple-net investing and sale-leaseback financing.

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