Vereit Yields 11%: No Longer Complicated Net Lease Story – VEREIT, Inc. (NYSE:VER)
Vereit (VER) is a triple-net REIT which has, for the past few years, not received the respect it deserves due to pending litigation regarding its misgivings in its past life as American Realty Capital Properties. VER has outsized exposure to the restaurant sector, which may be the reason it trades so cheaply. Still, sporting an 11% yield and positioned with strong liquidity, Wall Street may be missing the long-term picture. I rate shares a buy.
The Complicated Story Is No Longer So Complicated
VER owns a diversified portfolio of single-tenant net-lease real estate. VER owns 3,858 properties spread over the country, with primary exposure to retail, restaurant, office, and industrial industries:
Its retail and restaurants tenants had decent four-wall rent coverage at 2.63 times in 2019. The problem is that 2019 numbers mean little in current times. Cheesecake Factory (CAKE) recently declared to its landlords that it cannot pay rent. While CAKE is not one of VER’s top ten tenants, the fact that a national restaurant player would so boldly decide to stop paying rent may imply that other restaurants may follow suit. We can see below the list of VER’s other restaurant tenants – on the bright side, we can also see that VER leases to several grocery and convenience stores which have seen strong business recently:
While it is possible that VER may see a disruption in normal rent payments, I, however, do not predict material long-term impact. I predict that VER may need to issue temporary rent concessions or rent referrals to its tenants affected by coronavirus lockdowns, and would do so in return for tenant concessions such as longer lease terms or greater lease escalations.
In the past several years, VER has traded at a discount to triple-net REIT peers due to pending litigation stemming from its past life as American Capital Realty Properties. Even now, VER sports an 11% yield and trades at a large discount to peers which have yields around 5-6%. VER has announced settlement of all pending litigation as of January 2020, and recorded $815 million in litigation costs in 2019. This removes a significant overhang and may be the key necessary to enable VER to regain a premium to NAV.
Because of its high cost of capital and to fund the litigation costs, VER was a net seller in 2019. VER sold $1.06 billion in comparison with acquiring only $401.3 million in properties in 2019. A positive point is that these dispositions occurred at a cap rate of 6.7% versus 7.1% for acquisitions. Prior to the coronavirus outbreak, VER had guided to be a net acquirer in 2020, with $1 billion in expected acquisitions and $300 million in expected dispositions, both at cap rates between 6.5% and 7.5%. VER had guided for AFFO to decline from $0.69 in 2019 to $0.65 in 2020, likely due to the net selling in 2019. I expect VER to reduce capital spending in 2020 due to potential rent deferrals, but expect 2021 to be a year of “business as usual.”
VER had guided for 0.5% SS rent growth in 2020 – this might not happen due to the coronavirus, but another important takeaway is that this figure is significantly lower than the 1-1.5% seen at higher quality peers. Later in this report, I argue that the discount is nonetheless far too wide as compared to peers’, though for now I note that VER should be considered a lower quality triple-net REIT.
Balance Sheet In The Coronavirus Era
VER has a solid balance sheet rated BBB or equivalent by the credit agencies. VER has a well-staggered maturity profile.
Net debt to EBITDA stood at 5.7 times.
At year-end, VER had $1.35 billion in available liquidity from its credit facilities. This strong liquidity position is very important. Whereas its stock price seems to be implying a repeat of the 2008-2009 Great Financial Crisis when many REITs had to dilute shareholders to redeem debt maturities, VER’s liquidity is sufficient to fund nearly three years’ worth of debt maturities if needed. I believe that the market has allowed many REITs to trade at distressed multiples due to the possibility of near-term financial pressure, while ignoring that strong liquidity positions should allow these REITs to make it through the coronavirus period and regain their former financial profiles. VER’s balance sheet looks strong enough to withstand any near-term rent concessions due to the coronavirus.
In the long term, its 5.7 times debt to EBITDA position means that it has room to raise leverage to 6.5 times if needed. As a result, I am not concerned with its current high cost of capital, as I expect its share price to improve as the company returns to cash flow growth.
Valuation And Price Target
VER has guided for $0.65 in 2020 AFFO, but likely will not meet guidance. VER trades at 7.7 times AFFO and an 11% yield. Compare this to the 17 times FFO and 4.7% yield at Realty Income (O), or the 11 times FFO and 6% yield seen at Store Capital (STOR). In the long run, triple-net REITs can be peer-compared similar to how one would peer-compare banks. Over time, VER should be able to shape its portfolio similarly to STOR and O through acquisitions. VER does not generate nearly the same SS rent growth as peers, but does it deserve to trade at 35-40% discounts? Given the potential for the differences to subside in the long term, I think not.
My 12-month fair value estimate is $9.20 – a 6% yield. I anticipate O and STOR to rally to 3.8% and 4.4% yields, respectively, making my projected 6% yield at VER an adequate discount to peers. Shares have 90% total return upside.
The triple-net REIT space is highly competitive. As a result, acquisition cap rates may compress or worse, VER may reach for yield and acquire risky tenants. I don’t see too much evidence of this happening, as the market for real estate lending remains very large.
The rent shortfall may be worse than expected. It is possible that we see a large amount of bankruptcies in the triple-net space. In such a scenario, I expect triple-net REITs, including VER, to dispose of their vacant properties at high cap rates. In the coming months, we may see a test of triple-net REITs’ claims that their locations are critical to their tenants’ success.
VER has a checkered history. As a result, there is always reason for suspicion of undiscovered issues and more importantly, shares may always trade at a discount due to such fears. If shares continue to trade at a discount, then VER may not be able to compete on equal ground with peers. I view its high 11% yield as providing strong enough returns in a no-growth scenario, but note that much of the upside potential comes from multiple expansion.
VER trades as if it is about to see a complete implosion of its net lease tenants. I don’t see that happening, though I do expect some rent concessions in the near term. The 11% yield is far too high in light of the consistent revenue streams and high-quality business model. I rate shares a buy.
(TipRanks: buy VER)
25 Stocks I Like More Than VER
VER is just a buy – the Best of Breed portfolio features over 25 stocks rated strong buy or conviction buy. Some investors start by looking at valuation with a stock screener, and from these cheap companies try to find any that they can justify buying. I instead start with an assessment of quality, and only from the highest quality companies do I begin to search for value. My goal is to not only beat the market but to also do so with a high success rate.
Disclosure: I am/we are long VER, O, STOR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: DISCLAIMER: Julian Lin is not a Registered Investment Advisor or Financial Planner. While the information in his articles and his comments on SeekingAlpha.com or elsewhere may seem like financial advice, it is not, and it is provided for information purposes only. Do your own research or seek the advice of a qualified professional. You are responsible for your own investment decisions.