Net lease REIT STORE Capital Corp. has endured a rough ride this year.
In February, before the coronavirus had spread throughout the U.S., the REIT’s stock reached its 2020 peak of $40.05 per share. Fast forward to mid-May, and the stock price was hovering around $17.00 to $18.00 per share.
To be fair, stocks across the net lease REIT sector have taken a hit because of economic jitters caused by the coronavirus pandemic. But STORE’s stock fall-off stands out thanks to one of its largest shareholders: investing guru Warren Buffett. STORE is the only REIT stock in Buffett’s portfolio at Omaha, Neb.-based investment conglomerate Berkshire Hathaway Inc.
We can’t read Buffett’s mind, so we don’t know his current outlook on STORE. However, we do know his ownership stake in STORE remains the same as when he first bought his 18.6 million shares in 2017 at $20.25 apiece, just a few dollars above its current level. Therefore, STORE’s stock might be perceived as a “hold.”
While some observers raise concerns about the company’s lack of investment-grade tenants and its short-term challenges with rent collections, STORE executives express belief in the long-term success of the Scottsdale, Ariz.-based REIT.
“STORE will emerge from this pandemic in a strong position,” President and CEO Christopher Volk said during the company’s May 5 earnings call.
In that call, Mary Fedewa, chief operating officer, made it clear that the pandemic hasn’t altered the REIT’s strategy of investing in “profit center” assets. During the first quarter of this year, STORE spent $264 million on acquisitions at an average cap rate of 7.5 percent, and Fedewa signaled that STORE continues to hunt for acquisition opportunities.
STORE Capital did not return calls for comment.
The coronavirus pandemic might unlock acquisition opportunities for STORE as businesses seek capital through sale-leaseback deals, says Randy Blankstein, president of The Boulder Group, a Wilmette, Ill.-based real estate investment firm specializing in single-tenant net lease properties.
Fedewa said her REIT’s “profit center” strategy “was profitable going into COVID-19, and we believe these locations will be profitable after COVID-19. Our team is focused each and every day on delivering the best outcomes for our customers, our employees and our shareholders. And that is what we will continue to do.”
In the short term, though, STORE is coping with a dip in rent collections. In April, the REIT collected 68 percent of base rent and interest. That’s just a few percentage points below the April average for net lease REITs. Fedewa said STORE had reached agreements for collection of over 97 percent of April rents.
In a March 17 letter, Volk stressed the REIT’s diversification, noting that three-fourths of its rent payments come from tenants representing less than 1 percent of the rent total. Furthermore, he wrote, STORE’s 2,500 or so properties are spread across 112 industries and 49 states.
STORE tenants seeking rent relief are in industries temporarily disrupted because of the coronavirus pandemic rather than poor credit quality, according to Fedewa. “We are, therefore, optimistic that these tenants will rebound nicely as the economy opens up,” she said.
Nonetheless, an April 26 report from Newport Beach, Calif.-based real estate research and advisory firm Green Street Advisors LLC points out that among net lease REITs, STORE has one of the lowest levels of investment-grade tenants. On top of that, Green Street notes, STORE has a high level of exposure (19 percent) to industries that have been slammed by the pandemic, such as movie theaters, casual dining restaurants and gyms. By comparison, the REIT has lower exposure (6 percent) to industries that have flourished during the pandemic, including dollar stores, quick-service restaurants, drugstores, grocery stores and wholesale clubs.
Green Street warns that amid the shaky economic environment, STORE “is likely to see tougher lease negotiations and higher credit losses.”
In April, Fitch Ratings downgraded STORE’s ratings outlook from stable to negative. It cited “the prevailing uncertainty for retail businesses that are currently unable to generate revenue and the possibility of widespread lease non-performance and bankruptcy events, particularly within [the REIT’s] middle-market tenant roster.”
Fitch estimates two quarters of rent deferrals in 2020, totaling $102.5 million, will affect about one-third of STORE’s tenant roster. Major tenants include Fleet Farm, Ashley Furniture HomeStore, Cabela’s and AMC Theaters.
Despite STORE’s recent setbacks, some observers of the net lease sector are bullish on the REIT.
Alex Pettee, president and director of research and ETFs at Rowayton, Conn.-based investment adviser Hoya Capital Real Estate LLC, says STORE has been one of the strongest net lease REITs since its 2014 IPO and has established itself in the “upper echelon” of the sector, along with San Diego-based Realty Income Corp. and Orlando, Fla.-based National Retail Properties Inc.
“We’ve dubbed these three top-performing net lease REITs the ‘Power 3,’ because they have essentially carried the net lease sector on their backs over the past half-decade,” Pettee says. “These three are responsible for over 70 percent of the total net acquisition activity in the last two years and have delivered steady and consistent FFO growth in the face of the ‘retail apocalypse’ headwinds.”
Pettee emphasizes STORE’s focus on middle-market tenants rather than investment-grade tenants like CVS, FedEx and Walgreens.
“By climbing up the tenant-risk spectrum a bit—but managing the risk through other means—STORE has been able to buy properties at higher cap rates and achieve higher spreads relative to their cost of capital,” he says. “Cost of capital is the name of the game in the net lease REIT sector. Operating more like a financing company than other REIT sectors, external acquisitions are a critical component of the net lease business model.”
The pandemic has underscored the sector’s exposure to embattled retail tenants, Pettee acknowledges. Before the coronavirus outbreak, experiential and other “un-Amazonable” retail segments generally avoided the worst of the retail downturn, he says. Now, however, many of those segments—such as restaurants, movie theaters and gyms—are bearing the brunt of the pandemic’s social distancing requirements.
At this point, net lease REITs like STORE are beholden to coronavirus forecasts and “the politics of reopening America,” Pettee says.
“While the triple-net lease structure gives these REITs protection in the event of a garden-variety economic slowdown, the COVID-19 outbreak presents a potentially unknown risk in both magnitude and duration,” he notes. “A sooner-than-anticipated reopening could certainly be an upside catalyst for many of these beaten-down net lease sectors that have heavy exposure to closed segments of the economy.”
Blankstein says STORE and its net lease counterparts will generally fare well going forward. Why? The sector offers much higher returns than other alternative fixed-income vehicles like Treasury bonds and investors are pursuing stable investments with predictable cash flows.
“There will be net lease tenants that do not make it out of this current crisis, but the expectation is that most of the failed companies were already on a trajectory to fail,” Blankstein says. “The pandemic has just sped up this process.”
