Freestanding Retail REITs Expected to Continue Outperformance

Freestanding retail REITs are likely to remain market outperformers as long as the broader macroeconomic outlook remains uncertain, according to analysts.

As of Feb. 19, returns for freestanding retail REITs were 14.5 percent higher year-to-date. That compares with a 5.9 percent decline in returns for the FTSE/NAREIT All REIT Index.

R.J. Milligan, a senior analyst at Robert W. Baird & Co., describes the segment as “one of the top performers over the past 10 years.”

Craig Kucera, an analyst at Wunderlich Securities, Inc. agreed that freestanding retail REITs offer “some of the most consistent growth in earnings and dividends over multiple cycles.”

Much of the attraction of freestanding retail REITs can be attributed to investors looking for relative safety within the REIT sector, according to Milligan.

He points out that National Retail Properties, Inc. (NYSE: NNN) and Realty Income (NYSE: O), the segment’s best performers year-to-date, continued to increase their dividend through the last recession.

“Investors recognize the durability of these dividends in various economic cycles,” he said. Furthermore, freestanding retail REITs that were public companies in the last recession lost very little occupancy, Milligan said.

Today, freestanding retail REITs also have stronger balance sheets than they had heading into the last recession, Milligan added.

Acquisition Opportunities Look Plentiful

Freestanding retail REITs are also finding that the acquisition landscape is working in their favor.

“The size of the marketplace is significant,” Kucera said. He noted that estimates value the segment in the $2 trillion range. “Growth will continue to come through acquisitions as the organic growth of leases is relatively limited,” he added.

“You’re dealing with a very large universe of assets,” Milligan said. At the same time, the level of competition has diminished somewhat due to lower participation from non-traded REITs, which are not raising the same level of funds as in the last several years, he added. Meanwhile, VEREIT Inc. (NYSE: VER) is in the process of downsizing its portfolio – a contrast to its active acquisitions pace when it operated as American Realty Capital Properties, Inc., Milligan added.

Milligan said he expects to see significant acquisition volume this year given the attractive cost of capital, as well as public-to-public mergers and acquisitions. Milligan explained that for freestanding retail REITs trading at attractive multiples, acquiring a smaller triple-net lease “could potentially be very accretive.”

Kucera added that for the larger freestanding retail REITs that are buying one-off properties, “it takes a lot of transactions to grow yourself at the level the Street expects.”

As for potential concerns for the segment, the biggest is that freestanding retail REIT stocks are trading at peak valuations. However, “given the macro volatility, we are still comfortable buying the sector,” Milligan said.

“As the fear factor in the markets decline, you’ll probably see a bit more normalization on the 10-year Treasury, and probably a bit of air will come out of some of these names in the freestanding retail space,” Kucera observed.