A New Triple-Net REIT You Should Leave on the Street

NEW YORK (TheStreet) -- A new publicly traded REIT began trading on the New York Stock Exchange Thursday.

Spirit Realty Capital ( SRC) is a triple-net sector REIT based in Scottsdale and backed by Macquarie Group Holdings and hedge fund TPG-Axon among others. Morgan Stanley ( MS) is the lead underwriter of the offering.

Spirit planned to sell 27.06 million shares between $16 and $18 each. It opened at $15.

Excluding fees, Spirit Realty expects to generate about $418 million from the IPO (assuming mid-point price of $17 per share) and of that, $399 million will be used to pay debts.

Spirit counts $3.6 billion in real-estate investments and loans. Its 1,183 properties nationally were roughly 98.2% leased as of midyear.

The majority (98.3%) of the company's assets are free-standing triple-net properties (1,096) and the remaining (1.7%) are commercial mortgages and equipment loans (87 properties). The weighted average lease term for the portfolio is 11.4 years and 96% of the properties provide for increases in future base rent.

The portfolio of 1,096 owned properties are located in 47 states and are leased to approximately 165 tenants. Spirit's tenant base is comprised of 18 different industries, including general, specialty, and discount retail; restaurants; movie theaters; automotive dealers; educational and recreational facilities; and supermarkets.

Spirit appears to have a diverse portfolio of tenants spread across markets and industries. According to the company's S-11, Spirit focuses on investing in properties leased to unrated small and middle market companies that are determined to have attractive credit characteristics and stable operating histories.

My concern with Spirit's portfolio is that the tenant base has a high degree of non-rated credit and the exposure could lead to breaches or delay in payment of rent that may materially and adversely affect the company. Spirit's three largest tenants (based on average base rent) are Shopko/Pamida, 84 Properties and Carmike Cinemas -- representing around 40% of the overall portfolio.

In an IPO, the owners are attempting to raise capital for expanding the business, to cash out their interest for estate planning or any other myriad of reasons that all result in one thing: a premium price that offers little chance for buying your stake at a discount.

The problem with the Spirit Realty IPO is that three of the company's largest tenants have questionable business models and even with the debt reduction (from the IPO proceeds), the company will have high leverage and considerably high payout ratios (Spirit reported a loss of $21 million, or 82 cents, a share based on historic results for the first half, during which revenue totaled $141 million).

As explained by Kyle Gore, managing director of CGA Capital:
One has to wonder whether the recent spate of REIT IPOs -- particularly in the net lease sector -- signals a 'top tick' in investors' never-ending quest for yield, to the detriment of a focus on value, residual risk, and overall safety. 
Somehow, everyone forgot the mantra that returns are supposed to be risk-adjusted!  Witness the Spirit offering, in which over 40% of the asset base consists of a small town grocery stores net leased to a private equity-backed entity, movie theaters net leased to a chain focused almost exclusively on small and mid-sized communities, and specialty lumber yards net leased to a company whose primary business depends on homebuilders. 
While those tenants may prove to be well-run entities (note that Carmike Cinemas (CKEC) reported a record second quarter this year, but still generated relatively low net income) or backed by owners with strong resources (Sun Capital in the case of Shopko, and a Forbes 400 member in the case of 84 Lumber), in each case, the underlying assets would have very low residual value or appeal to other users in the event of non-renewals or credit defaults.

In today's uncertain economic environment, I would steer away from Spirit Realty and instead consider companies with a low cost of capital and established dividend payment histories.

These higher quality triple-net sector REITs include Realty Income ( O), National Retail Properties ( NNN) and W.P. Carey ( WPC) -- all of which have paid consistent and increased dividends.

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

More from Opinion

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Throwback Thursday: Intel Edition

Throwback Thursday: Intel Edition

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

Wednesday Wrap-Up: GE and Facebook

Wednesday Wrap-Up: GE and Facebook