Triple Net Assets Might Find It Difficult to Outperform This Year
The triple net sector is historically more sensitive to rate hikes.
While REITs should see continued stability in a rising rate environment, according to a recent Mizuho analysis, the triple net sector shows some signs of stress.
Overall, Mizuho remains bullish on the US economic recovery in the wake of the COVID-19 crisis. Transactions are increasing, earnings are bouncing back from 2020-era lows, and the resurgence has led to a 55 basis point rise in 10-year yields. A recent analysis notes that while REITs have previously outperformed over multi-year periods of rising rates, most notably in the mid-2000s, the triple net sector is historically more sensitive to rate hikes. But Mizuho also cautions against abandoning the sector altogether, as earnings growth expectations remain high and rates are expected to hit a ceiling of around 1.75 to 2%.
The firm entered 2021 overweight on triple nets, noting that the sector has an attractive risk/reward proposition and has sustained rent collections in the mid-90% range despite COVID-19. But in the face of rising rates and incremental risks (including a potential 1031 repeal), Mizuho moved to a neutral rating on triple net REITs. It also downgraded its position on Realty Income and Spirit Capital Realty from buy to neutral.
“We think Triple Net’s longer-term leases with fixed rent bumps and historically-higher sensitivity to rates, will make it difficult for the sector to outperform this year,” Mizuho analysts wrote in the report. Analysts also noted that the inability to reprice leases in an economy during inflationary periods (unlike sectors like hotel and residential) means longer-duration and lower-volatility REITs typically underperform more cyclical asset classes.
Despite this, single tenant triple net assets have become more of an investor favorite as the pandemic drags on, since these assets tend to be relatively stable. Both demand and deal volume for single-tenant triple-net assets increased throughout the third and fourth quarters, and developers have also begun launching new projects to serve demand in that niche.