Episode 027: Nothing But Net - NNN Show TAKING A GAMBLE ON BETTER REAL ESTATE RESEARCH
SPENSER ALLAWAY EXPLAINS THE RESEARCH BEHIND CHOOSING QUALITY REAL ESTATE INVESTMENTS
Hosts Michael Flight and Adam Carswell on the Nothing But Net – NNN Show.
March 8, 2022 | TAKING A GAMBLE ON BETTER REAL ESTATE RESEARCH
In this episode, hosts Adam Carswell and Michael Flight are joined by Spenser Allaway, Senior Analyst at Green Street, to discuss how Green Street ranks various property types by their long-term return prospects to give proprietary stock recommendations. Spenser focuses on Net Lease, Gaming and Self-Storage real estate prospects for investment portfolios, explaining how to evaluate properties utilizing important data and research in these specific markets. Michael, Adam and Spenser expand on the types of Triple Net Lease properties Green Street covers, as well as the commonalities and differences between the Net Lease and Gaming sectors of real estate. Spenser also explains how Green Street’s research and analytics provide clients with pricing in real time to infer where pricing is on different net lease products, and realistic expectations of the true internal growth of Net Lease REITs. These analyses also help summarize the themes of the market sector and let clients pay attention to companies that best approximate their own underwriting parameters to best fit their investment focus. Closing the show, Spenser, Adam and Michael touch on what research Green Street offers clients looking to invest in private versus public real estate.
Related Link: Commercial Real Estate Statistics and Trends 2021
Learn more about International Investing and all things Triple Net on other episodes of The Nothing But Net – NNN Show. This show is a podcast all about the benefits of acquiring and owning Net Lease Properties (also known as NNN, Triple Net, Triple-Net Single-Tenant or Single-Tenant Triple-Net Lease properties). Listen to or watch this podcast on the Liberty Real Estate Fund Nothing But Net YouTube channel.
Spenser Allaway on Better Real Estate Research
Spencer Allaway is a senior analyst at Green Street, a global real estate research and analytics company that provides valuable information on markets, different industry segments and industry trends. Over her time at Green Street, Spenser has worked in REIT research, covering the publicly traded names, as well as the traditional net lease space, gaming REIT sector (a sub-sector of net lease), and storage sector. Unlike the more competitive stock market, the real estate market is the largest asset class to invest in, holding $280 trillion in assets. A very unique aspect of real estate and REITs is the fact that the commercial real estate market offers something that other asset classes don’t: a dual market of public equities that trade on public exchanges and in the private investment market. The private market, if we think of the abundance and the activity in terms of the transaction market, provides real-time comparisons and pricing, which allows analysts to more accurately ascribe value and perform a bottom-up analysis for REITs. In the traditional Net Lease sector, REITs are often trading at massive premiums to their asset values; REITs can go out to the market, issue equity at extremely attractive pricing, and deploy the capital and proceeds in the private market at some appropriate, often very attractive, spread to their portfolio cap rates.
Green Street’s Commercial Real Estate Intelligence
Green City was founded in 1985 by University of Chicago graduate Mike Kirby and REIT executive Jon Fosheim. Green Street was one of the first independent providers of commercial real estate intelligence on publicly traded REITs. Since Green Street is not affiliated with any investment banking arm, it doesn’t have any conflicts of interest when it comes to writing checks of research or making investment recommendations. The company has solidified its position as the preeminent source of commercial real estate analytics, research, news and advisory services relating to the public and private markets. Green Street covers 18 property sectors within the US (approximately 85 companies) as well as seven sectors in Europe. The triple net lease structure of some of their investments is appealing to many investors because the lease type offers a safe, stable investment with predictable cash flows that has proven to be pandemic-resistant, even with closures and capacity restrictions. The majority of net lease properties are occupied by large corporate tenants, aside from those doing sale leasebacks, making the investments akin to bonds wrapped in real estate.
Net Lease Investment Strategy
On average, about 70% of Green Street’s net lease investments are in the retail sector. The office sector is another prominent property type within portfolios, as well as the trending industrial sector. The agricultural sector is another net lease investment type, which features a percentage rent with a set fixed rent and an overage on how much the businesses sell their crops for. There is also variable rent that goes into some net lease products. For example retail business percentage rents were very popular in the 1970s when inflation was at large. The percentage rent component protected investors because the retailers could raise their prices and pass that through to their customers. However, institutional bankers didn’t like percentage rent because they wouldn’t lend on percentage rent, causing that structure to mostly disappear until the recent pandemic when owners had to renegotiate tenant leases, putting percentage rents back into retail leases.
Key Metrics of Net Lease Investments & REITs
Net lease investors are typically those who are underwriting their own deals, which sometimes gives them more access to property level information or sub-market information than analysts have available to them. For companies covering publicly traded REITs, i.e. thousands of properties, the disclosure in the net lease space from REITs is hardest to estimate since analysts don’t receive rent coverage metrics or insight into tenants’ health. But because of the diversification of tenant and industry concentrations, no one tenant’s ailments or issues are going to disrupt the REIT’s daily cash flows. Large triple net lease companies that invest in retail real estate could be investing in many different stores at once, from sporting goods, pharmacies and grocery stores to restaurants and banks. So it’s hard to get an idea of each individual property within the REIT because that’s only 70% of the portfolio with a vast array of tenants and industries. On top of that, the tenant concentration typically isn’t beyond 5% for any one tenant. In a REIT’s defense, it doesn’t really matter how the tenants are doing day to day because they pay their monthly rent, which is what really matters. Conversely for a private real estate investor, the due diligence on an asset is very important. Private investors should understand property level financials, what the rent coverage would be for the lease underwriting, what the surrounding demographics are, and what the supply-demand dynamic in that particular market or sub-market is. Potential of disruptors in a private industry is also important to note, like automation and downsizing trends.
The coverage ratio, or health ratio, is another factor that can help investors understand the health of a net lease investment. If you could get sales for a particular store, you would know how well they are covering the rent. You want to find a happy medium where your tenants’ operating performance is going to be in line with the rent you charge them to get a good return while knowing that your tenants are going to be able to keep up with payments. A good rule of thumb for a health coverage ratio is that if it is above 10%, that usually means the tenant is in trouble, except for a tenant like a jewelry store that has high margins. Comparatively, a grocery store or a hardware store with a coverage ratio anywhere near 10% would be going out of business because those are much lower-margin businesses. So, properties like these would want coverage ratios around 3-4%.
Commonalities and Differences Between Net Lease & Gaming Sectors
The primary commonality between traditional net lease and gaming sectors is the structure of the lease. In both cases, these REITs are leasing real estate to tenants under long-term triple net leases, which are typically subject to an annual escalator that ranges from about 1-2%. Like in the traditional net lease space, the gaming sector tenants are operators that are responsible for the property taxes, insurance, operating expenses and maintenance repairs. The key differentiator is the tenant concentration. In the net lease space, single tenants usually don’t make up more than 5% of the portfolio revenue and industries don’t make up more than 15% of the revenue. In the gaming sector, industry concentration is 100% and the tenant concentration is much higher. Over the last 24 months, tenant concentration in the gaming sector has not come down from close to 85% revenue for one operator. Now, it ranges anywhere from about 40-70% revenue for one gaming operator, which is significantly higher than for a single operator in the traditional net lease space.
Going back to the lease terms, though both traditional net lease and gaming investments have long-term triple net leases, the gaming sector has substantially longer lease terms. Gaming leases typically range from 30 to 60 years, whereas net lease portfolios have lease terms lasting closer to 15-20 years.
Another difference between sectors is that a typical annual rent escalator for traditional net lease properties is somewhere between 1-2%. In gaming, you should as a landlord expect to have truly about a 2% annual rent escalator achieved. In the traditional Net Lease sector, the expectation in terms of internal growth is that these net lease REITs will experience credit losses from their tenants from unforeseen occupancy losses. The retail market, for example, has had troubles in the last 5-6 years because tenants may all of a sudden go bankrupt, have credit events or have rent restructuring initiatives. Traditional retail net lease names tend to have negative NOI growth. The gaming sector, on the other hand, has had true NOI growth of about 2% a year. On average, traditional net lease names trade at massive premiums to their asset value.
Impact of COVID and Digital Gaming on Gaming REITs
During the COVID pandemic, gaming REITs had to close down, really affecting the large concentration of the gaming industry in Las Vegas, Nevada. However, the pandemic actually benefited gaming REITs because it provided a worst-case scenario that proved their resistance to closure. At one point, casinos were closed for two months at a time, had zero revenue coming through the door. Once they reopened, traffic was initially very depressed because people were scared to travel and the casinos had capacity restrictions. But, the rent payments to the REITs by their operators effectively had no interruptions. The gaming REITs received all of their rent through that time from their really secure triple net lease structures.
With the rise of digital gaming and NFT trading that appears almost like gamification, the physical gaming market does not become negatively affected, unlike e-commerce and the world of retail that is cannibalistic. People have a finite amount of money they are going to spend in casinos, with the profits being shared among more outlets. In the gaming space, digital gaming is viewed as additive because it has very much come by way of sports betting. What digital gaming has done is brought in the younger generations that weren’t typically going to casinos and weren’t engaged in that type of gambling lifestyle. Official digital platforms that allow friends to bet with one another bring in these younger users, which has grown the overall demand for the physical gaming industry. REITs will gain better tenant credit because their operators are going to have healthier balance sheets with more revenue coming through the door, raising their coverage ratios.
Another trend observed is that in order to have an online presence of digital gaming, you have to have some affiliation to a ground license. So, the owners of the ground licenses are the operators that operate at a brick-and-mortar casino. In order to have online licensing availability, the actual casinos get to use their land presence to sell off the rights to what is called gaming skins, which gives the casinos another income source.
The growing younger user base and those who like digital gaming also benefits more regional operators than larger markets, like Las Vegas. Regional casinos have patrons that frequent the physical property but now also have digital gaming licensed by those casinos and may spend money at home, as well, which gives the casinos more revenue coming in from one patron in a regional market. So, destination-based casinos don’t have as much upside than the regional operators will have by way of digital gaming, except for the additional younger users.
Utilizing Green Street’s Research for NNN Investing
Financial institutions, asset managers and private real estate investors look towards Green Streets’s investment recommendations and reports to help inform them where they want to put capital to work. Their research provides pricing in real time because Green Street provides disclosure around the comparisons and deals they work on. Different deal can be differentiated between the pricing they are achieving on investment-grade versus non-investment grade tenants, flat leases versus those with escalators, different property types and different geographies. Because Green Street has net lease REITs under their coverage that have very differentiated strategies, clients can pay attention to the companies that best approximate their own underwriting parameters. For example, an investor interested in smaller middle-market tenants or net lease products would want to focus on one of the companies in their coverage universe called store capital. Because that company does and prices deals within those same parameters. If investors are more focused on investment-grade tenants like CVS, they should focus on a realty income or a national NNN company.
Green Street also provides a very realistic expectation of the true internal growth offered by the net lease investments, educating investors on the credit losses that may occur in these investments that informs their ultimate decisions on deals. The research also keeps investors apprised of thematic views in the NNN sector by tracking businesses growth and strategies. Investors can find cap rate and square-foot pricing information, as well as geographic trends on their ideal markets and companies. On the private side of real estate investing, clients can find detailed information on the top 50 commercial real estate markets in the US, expanding to more than 300 sub-markets, and find property market grades, CPI (commercial property index time series of asset values by sectors), and demographic macroeconomic data that follows trends. These analyses can inform where population growth is headed, what the display supply per capita is, what deliveries coming online in the next two years look like and more. Green Street is also creating a sales comparison database that contains over 75,000 verified sales transactions compiled over the last 15 years – a total of approximately $4 trillion in value.
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About the Podcast Hosts:
Michael Flight was named the Godfather of Blockchain Real Estate by Forbes Crypto. Michael achieved that distinction by co-founding Liberty Real Estate Fund, the World’s First Net Lease Security Token Fund, creating the Blockchain Real Estate Summit. More recently co-founding Invest On Main (IOM.ai) the Real Estate & Alternative Asset marketplace of the future and AcceleratedLaw a faster, cheaper way to create and tokenize securities offerings!
Michael is a real estate entrepreneur and real estate tokenization pioneer who is an expert in retail real estate investment, redevelopment and real estate on the blockchain. He started his commercial real estate career in 1985, and then co-founded Concordia Realty Corporation in 1990, which continues to partner with some of the world’s most well-known banks, insurance companies, hedge funds and institutional investors in many successful investments.
Liberty Real Estate Fund LLC is The World’s First Single-Tenant Net-Lease Security Token FundTM, joining 30 plus years of institutional real estate investment experience with blockchain technology to deliver very stable, diversified, tax efficient returns combined with liquidity, security and transparency.
Liberty is a real estate investment fund that acquires Single-Tenant Net-Leased (NNN) essential business retail, auto service and medical properties in the United States. It is designed for investors to achieve: Geographic Diversification; Industry Diversification; Tenant Credit Strength and is built with hard assets that have intrinsic value. Our portfolio of Net Lease properties is constructed with brand-name Essential Businesses operating in high growth markets throughout the United States. These Net Lease assets have long term contractual rents backed by excellent brand name, well capitalized companies.
Liberty is focused on investing in high quality, well located Single-Tenant Net-Leased (NNN) properties in targeted high growth, low tax areas of the United States. The portfolio has been specifically designed to provide stable, recession resistant income combined with inflation protected wealth preservation and equity growth.
DISCLOSURES, LEGAL AND TAX COUNSEL: Liberty Real Estate Fund LLC and Liberty Equity Management LLC (collectively “Liberty”) and their affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction or undertaking. Liberty highly encourages individuals and investors to seek the counsel of a qualified attorney as well as seek the counsel of a tax professional or Certified Public Accountant (CPA) to determine if there are any potential tax liabilities or consequences as the result of anything contained herein. NO GUARANTEE: All users of this website should understand there are NO GUARANTEES of any success, outcome or profitability of any transaction or undertaking, expressed or implied by Liberty or any of its members, shareholders, officers or affiliates and will NOT be liable for any financial or other losses or damages incurred as a result of any undertaking. Go HERE to view complete DISCLOSURES.