The Best Offense Is A Great Defense


&l;p&g;&l;img class=&q;dam-image getty size-large wp-image-963162326&q; src=&q;https://specials-images.forbesimg.com/dam/imageserve/963162326/960×0.jpg?fit=scale&q; data-height=&q;639&q; data-width=&q;960&q;&g; BOSTON, MA – MAY 27: Jayson Tatum #0 of the Boston Celtics defends LeBron James #23 of the Cleveland Cavaliers during Game Seven of the 2018 NBA Eastern Conference Finals at TD Garden on May 27, 2018 in Boston, Massachusetts. (Photo by Maddie Meyer/Getty Images)

Anyone who loves sports has heard, &a;ldquo;The best offense is a good defense.&a;rdquo; That&a;rsquo;s how many teams become champions.


As a onetime college basketball player and now fan (go Tar Heels!), I love watching players score, especially from the 3-point line. There&a;rsquo;s nothing more satisfying than witnessing a 30-footer land perfectly inside the rim with a thunderously quiet, &a;ldquo;swoosh!&a;rdquo;

But as basketball fans know, as fun as it is to watch the offense score, it&a;rsquo;s defense that wins games. Th&l;span&g;e same&a;rsquo;s true with investing.&l;/span&g;

&l;p class=&q;tweet_line&q;&g;Smart investors know a good offense is no substitute for good defense , especially today with many macro-economic concerns related to international trade.


A defensive investment strategy aims to minimize risk of losing principal, and in his legendary book, &l;em&g;The Intelligent Investor&l;/em&g;, Benjamin Graham makes a crucial distinction between a &a;ldquo;defensive&a;rdquo; investor and an &a;ldquo;enterprising&a;rdquo; investor.

The defensive investor&a;rsquo;s chief emphasis is &a;ldquo;the avoidance of serious mistakes or losses&a;rdquo; with a secondary aim of &a;ldquo;freedom from effort, annoyance, and the need for making frequent decisions.&a;rdquo; Simply, a defensive investment strategy is one in which a portfolio is meant to protect against significant losses from major market downturns.


It&a;rsquo;s time to get defensive today, as it seems there&a;rsquo;s a big disconnect right now. The Federal Reserve is signaling another rate hike in June, and the market seems to be focused on the consumer, without much focus on the primary catalyst driving corporate stocks: Cap-Ex.

Why Cap-Ex?

Remember, the recently passed Tax Reform provides enhanced incentives for U.S. companies to reinvest in machinery, equipment, and inventory. We&a;rsquo;ve already seen significant investments from FedEx and Apple and the wave for corporate expansion is just getting started.


What are the opportunities?

&l;p class=&q;tweet_line&q;&g;When a company invests in more equipment, it will need added space to accommodate the growing cap-ex demand , and this means companies will require more buildings.

(I&a;rsquo;ve provided an updated explanation about cap-ex for subscribers to &l;a href=&q;https://esp.forbes.com/subscribe?PC=VE&q; target=&q;_blank&q;&g;&l;em&g;Forbes Real Estate Investor&l;/em&g;&l;/a&g; in the June issue, out Friday.)

In this article, I&a;rsquo;m focusing on the most defensive Net Lease REITs poised to benefit from the growing cap-ex boom. These REITs are also best-positioned to benefit from the &a;ldquo;building boom,&a;rdquo; while providing investors with the most durable defensive dividend income.


&l;strong&g;5 of The Most Defensive REITs&l;/strong&g;

&l;strong&g;Realty Income&l;/strong&g; (O) has a retail portfolio with over 90% of rent from tenants with a service, non-discretionary and/or low price point component to their business. This allows the company&a;rsquo;s tenants to compete more effectively with e-commerce, and operate successfully in a variety of economic environments.

These factors have been particularly relevant in today&s;s retail climate where the vast majority of recent U.S. retailer bankruptcies have been in industries without these characteristics.


Realty Income pays shareholders, each month, an annualized 5% dividend from the cash flow of over 5,300 owned properties under long-term lease agreements with regional and national commercial tenants, in 49 states and Puerto Rico.

In their most-recent conference call, CEO John Case said the company had invested $510 million in high-quality property acquisitions in the first quarter, and over 50% of rental revenue came from investment grade-rated tenants. Realty Income&a;rsquo;s quality focus is reflected in their portfolio occupancy, at 98.6% – their highest quarter-end occupancy in over 10 years.


Realty Income has built a diverse platform that includes convenience, drug, and dollar stores; transportation services, theaters, health/fitness, and quick serve (dining).

&l;strong&g;W.P. Carey&l;/strong&g; (WPC), was one of the first companies to build a Net Lease vehicle to assist global companies to monetize free-standing real estate, with a successful track record of investing through multiple economic cycles.

As of 1Q-18, Carey owned 886 properties (85 million square feet) in the U.S. and Europe, with industrial, office, retail, and warehouse facilities. Top 10 tenants represent 32.3% of ABR (annual base rent). As of Q1-18, the company&a;rsquo;s enterprise value was approximately $10.9 billion.


Carey views U.S. retail real estate as overbuilt, and has invested internationally for 19 years. Around 35% of non-U.S. revenue includes Germany (8.8%), United Kingdom (5.2%), Spain (4.7%), Poland (2.8%) and France (2.2%). Carey&a;rsquo;s European investments require expertise and experience that generate a flow of attractive deals.

Among other key differentiators: WPC does not have substantial retail exposure (compared to Realty Income). Another is its growth drivers: approximately 95% of leases have fixed or CPI-based contractual rent increases. By crafting leases directly with tenants, the company gains a competitive advantage for predictable rent growth, achieving stronger institutional quality leases with longer lease terms, and greater downside protections.


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Carey generates around 80% of AFFO (adjusted funds from operations) from its owned real estate operations and 20% of AFFO from its investment management business (in the process of unwinding). With a conservative payout ratio of 79%, the company continues to grow the 6.17% dividend (over 21 years in a row), and notably, has never cut its dividend.

&l;strong&g;STORE Capital Corporation&l;/strong&g; (STOR) is a leader in acquisition, investment and management of Single Tenant Operational Real Estate – its target market and name inspiration – with over 2,000 locations in 49 states, highly diversified across customers, brand names, business concepts, industries and geography &a;ndash; and 99.6% leased.


Seeing low correlations between net lease real estate values and interest rates, STORE used built-in lease escalators and far shorter durations (a measure calculating lease values and interest rate impact), leveraged 42% of its assets at cost with virtually no floating rate debt, and evenly laddered debt maturities out ten years.

Additional growth factors: the lowest straight-lined rents among its net lease peers, an even bigger AFFO gap, 1.8% annual tenant contractual rent increases, approximate 70% dividend payout ratio, and 4.7% annual dividend.

Similar to the book &l;em&g;Moneyball,&l;/em&g; where the Oakland A&a;rsquo;s statistically determined the most expensive athletes are not necessarily the ones that help a team win &a;ndash; STORE&a;rsquo;s targeting of higher-value real estate tends to correspond to lower cap rates and return potential. Broad investment diversity drives investment grade income performance from tenants who otherwise have no credit ratings; STORE only invests in profit center real estate.


STORE&a;rsquo;s customers would rather have a landlord than commit equity and have a banker. Contracts and not real estate define shareholder investment risk. Investment grade returns mean shareholder disclosure must be given at a portfolio level. STORE has provided such unique disclosure since becoming a public company in 2014.

Berkshire Hathaway made its only REIT investment- for 9.8% of the company in summer 2017 – validating STORE&a;rsquo;s defining investment approach.

&l;strong&g;Monmouth Real Estate Investment Corporation&l;/strong&g; (MNR) is one of the oldest public equity REITs in the U.S., founded in 1968. The Company specializes in single tenant, net-leased industrial properties in long-term leases to investment-grade tenants, with 110 properties, approximately 20.3 million rentable square feet, across 30 states, with substantial exposure to the East Coast. The Company also owns a portfolio of REIT securities.


Monmouth has a long-standing real estate relationship with global shipping giant FEDEX and subsidiaries, representing over 55% of annual rent, and balanced with other high-quality tenants including Siemens, Anheuser-Busch, and Caterpillar.

E-commerce growth is providing a tailwind to industrial space demand, and retail&a;rsquo;s shift from traditional brick-and-mortar stores to e-commerce has led to significant demand for large, modern industrial distribution centers. MNR&a;rsquo;s FedEx locations are coveted for large businesses, drawing major retailers so goods can get delivered to customers as fast as possible.


Monmouth&a;rsquo;s AFFO (excluding securities investments) for the second quarter ending 3/31, was $16.8 million, $0.22 per diluted share. Properties were over 99% occupied, for the ninth consecutive quarter.

Monmouth also held $144.6 million in marketable REIT securities, 8.3% of its undepreciated assets, generating $2.9 million in dividend and interest income during the quarter.

Last October, Monmouth raised its common dividend to $0.17 per share – a 4.39% annual yield, with a 77% AFFO dividend payout ratio. Monmouth has maintained or increased its common stock dividend over 26 consecutive years.


The combination of high-quality metrics including building age (youngest among peers), investment grade tenants, and high occupancy shows Monmouth&a;rsquo;s durability.

&l;strong&g;STAG Industrial, Inc&l;/strong&g;. (STAG) operates 356 properties in37 states, with approximately 70 million

rentable square feet. The &a;ldquo;Single Tenant Acquisition Group&a;rdquo; seeks to acquire individual, single-tenant, stand-alone, industrial properties priced according to the binary nature of their cash flows, which mitigates risk and enhances stability of cash flow from the portfolio.

STAG&a;rsquo;s monthly dividends (a 5.35% annual yield), have increased every year since going public in 2011.

The company uses a relative value investment model and develops operational expertise in target markets, delivering income and growth to shareholders. STAG looks to identify and acquire mispriced assets in Primary and Secondary markets – secondary markets defined as &q;net rentable square footage ranging between approximately 25 million and 200 million square feet, located outside the 29 largest industrial metropolitan areas.&a;rdquo; And due to its Class B (secondary market) investment rationale, the company enjoys low capital expenditures and lower tenant improvement costs (relative to other property types).

STAG has outsized automotive exposure (12.9%) – &a;nbsp;advantageous given current pro-growth policies. The U.S. has already seen a number of automotive announcements, which should benefit STAG&s;s business model.

The automotive exposure spreads across 14 states and has Original Equipment Manufacturer (OEM) relationships with Ford, Chrysler, General Motors, BMW, Toyota, and Hyundai; and auto plant relationships in nine facilities, for Jeep Cherokee, Ford 150, Cadillac, Camaro, and others.

STAG&a;rsquo;s balance sheet is investment grade, with strong liquidity (~$350 million), and a safe dividend (78% payout ratio).

I own shares in O, WPC, STOR, MNR, and STAG.

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