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The Superiority of NETSTREIT over Realty Income The Reasons We Prefer Netstreit Over Realty Income

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If you do what everyone else does, you’re going to get the same results that everyone else gets. – Charlie T. Munger

Some of the most reliable valuation indicators show the S&P 500 index in overvaluation territory. But much of the excitement is concentrated in just a few stocks. For instance, Tesla (TSLA) is trading with a forward price/earnings ratio of around 80x, despite significant headwinds on the horizon. We do believe EVs will continue gaining market share over ICE vehicles, but competitive pressures will make earnings growth increasingly difficult. NVIDIA (NVDA) has delivered impressive growth, but much is probably already factored in the 40x forward price/earnings ratio, as is probably the case with Amazon’s (AMZN) 57x multiple. We will not analyze each of the “magnificent seven” companies, but as a group, they look expensive.

Still, one can almost always find a corner of the market that is either reasonably valued or undervalued. In the case of real estate, it seems to have been overly punished by the increase in global interest rates, and some solid companies like Realty Income (NYSE:O) and NETSTREIT (NYSE:NTST) have not really participated in this year’s gains.

We have covered both in the past, starting coverage of Realty Income with a ‘Sell’ rating at the end of 2021. Since then, shares have delivered a total return of negative 8%, vastly underperforming. Our main point was that despite the VEREIT acquisition expected to be immediately accretive, shares were extremely overvalued. We then compared Realty Income to STORE Capital, reaching the conclusion that STORE Capital was the better value. While we were right in preferring STORE Capital, as it went to be acquired at a premium, we updated Realty Income’s rating to ‘Hold’ due to the low interest rate environment but would have been wiser to leave it as a ‘Sell’. We have covered NETSTREIT more extensively, starting with a ‘Hold’ rating, then upgrading it to a ‘Buy’, and then to ‘Strong Buy’ after Q2 results. Since then it has reported Q3 results, and Realty Income has announced the acquisition of Spirit Realty Capital (SRC) in an all-stock transaction. In this article, we are updating our analysis of both companies, considering the current economic environment and outlook and recent developments at both companies, and also explaining why we prefer NETSTREIT over Realty Income.





Realty Income vs NETSTREIT: A Battle of Balance Sheets and Acquisitions

Realty Income vs NETSTREIT: A Battle of Balance Sheets and Acquisitions

Realty Income is making big moves in the acquisition game, but some are not as impressed with the size and risk that comes with it. With a mere 2.5% accretive transaction, investors were left wanting more. This has led some to believe that Realty Income is straying away from its core competencies, making investment decisions that do not yield the expected returns.

On the other hand, NETSTREIT is turning heads with its retail acquisitions, showcasing examples with higher cash cap rates, such as the Walmart and Sam’s Club acquisition at a 6.6% cash cap rate. Recent acquisitions have boasted an average cash cap rate of 7%, proving that the company can invest at above-market yields without compromising on quality tenants.

However, concerns arise about NETSTREIT’s lack of disclosure regarding average rental increases and the percentage of leases with CPI escalation clauses. Despite this, the company seems to be addressing this issue, as evidenced by CEO Mark Manheimer’s comments in the recent earnings calls.

“While all of these market dynamics are resulting in more attractive cap rates, we’re also seeing an increased willingness by retailers, especially those committed to growing their store count, to sign leases with longer lease terms and embedded rent escalations.”

“We do see a pretty attractive opportunity to not only accretively recycle capital, but also extend out lease terms by replacing those assets with longer lease term assets with better rental increases and potentially better properties, and we believe we can do that accretively.”

Financials

Realty Income enjoys significant operating leverage due to its massive size, with G&A as a percentage of total revenue at ~3.8%, leaving peers far behind. In contrast, NETSTREIT has room to grow, with an opportunity to increase earnings as it closes the gap with competitors.

ESG

NETSTREIT takes the lead in ESG considerations, particularly in its avoidance of certain sectors like tobacco and gambling. Although Realty Income has dabbled in sales-leaseback transactions with casinos, it has shown commitment to an ESG program and detailed sustainability initiatives.

NETSTREIT’s ESG program involves the addition of green lease provisions and relationships with ESG contacts at their tenants. Additionally, the company has a sustainability-linked senior unsecured credit facility, providing cheaper financing upon meeting certain ESG criteria.

Dividends

Realty Income’s impressive 29 consecutive years of rising dividends stands out, but its CAGR of only around 4.3% and a relatively high AFFO payout ratio raise some concerns. On the other hand, NETSTREIT recently increased its quarterly dividend and maintains a lower AFFO payout ratio.

Balance Sheet

Both companies boast conservative balance sheets, with Realty Income having a net debt to adjusted EBITDAre leverage ratio of ~5.2x, while NETSTREIT is currently below its target leverage ratio at ~4.2x. This signifies room for NETSTREIT to increase leverage and drive profits.





High-Value Real Estate Investment for 2024