Broadstone Net Lease Trading at a Discount, but Better Opportunities Elsewhere (NYSE: BNL)
Thesis: A solid portfolio, but better opportunities available
Broadstone Net Lease (NYSE: BNL) is a highly diversified net leasehold real estate investment trust (“REIT”) that has been investing in space for approximately 15 years but has only gone public on the NYSE in 2020.
Year-to-date, BNL has outsold the Vanguard Real Estate ETF (VNQ) as well as the NETLease Corporate Real Estate ETF (NETL), with the newcomer net lease down almost 20%.
This is despite BNL’s portfolio focus on above-average rent increases and strong rent collection statistics during the pandemic.
In my view, the market has discounted BNL more than the average REIT due to its low exposure to investment grade tenants of around 15% of contract rent. Like fellow highly diversified net lease REIT, WP Carey Inc. (WPC), BNL hedges lower tenant credit risk through high diversification as well as landlord-friendly lease terms, such as above-average rent increases, tenant financial reports and head leases (cross-default clauses involving multiple properties leased to the same tenant).
Based on a 2022 AFFO guidance midpoint per share of $1.40, BNL is currently trading at a price/AFFO multiple of 14.3x at a stock price of approximately $20. That’s a bit less than WPC’s current AFFO multiple of 14.8x, but IMHO WPC more than makes up for that slight premium with greater exposure to investment grade tenants, a slightly larger share of industrial properties in the portfolio, and a much larger share of CPI-related rent increases.
As such, while BNL is a strong holding, I would prefer to allocate investment dollars to WPC at this time.
Broadstone Net Lease Update
While I wouldn’t say BNL has a significant competitive advantage over its peers, such as WPC’s dominant position as a leaseback provider, cost of capital and asset quality of Agree Realty Corporation (ADC ), or the size and scale of Realty Income (O), i would like to point out that BNL has a few positives in its favour.
First, BNL has very few vacancies in its portfolio of over 750 properties. Second, the vast majority (94.2%) of BNL properties benefit from some form of tenant financial reporting, either at the company level only or also at the unit level (i.e. i.e. the store or the property).
Third, BNL’s portfolio is highly diversified, far more than the average net rental REIT. Evidenced by the fact that the ten leading tenants of BNL represent only 17.1% of the total rent.
It is both a strength and a weakness. This is a weakness because the market never seems to know how to price diversified REITs, and so these stocks typically trade at a price below their sum-of-the-parts valuation. But diversification is a strength, and likely necessary, for a REIT like BNL that focuses on lower-credit-grade tenants.
Likewise, diversification also offers the benefit of being able to seek attractive acquisition opportunities across a number of industries and property types, depending on which is the most attractive and opportunistic at any given time.
This factor makes BNL somewhat similar to STORE Capital (STOR) and Essential Properties Realty Trust (EPRT), which also focus on non-IG tenants, but BNL cannot boast like these two that the majority of its properties were acquired through sale-leaseback. using his internal lease form which includes all or nearly all of his preferred lease terms.
Fourth, partly as a result of this focus on non-IG tenants, BNL benefits from above-average contractual rent increases, averaging 2.0% across the entire portfolio.
In the first quarter, BNL invested $210 million in 27 properties at a weighted average opening capitalization rate of 5.7%. This average entry cap rate is significantly lower than BNL’s typical vesting cap rate range of 6.3% to 7.2% since 2015. But here’s an additional comment from CEO Chris Czarnecki at the conference telephone call on the results of the first quarter:
The leases include a weighted average lease term of 19.3 years and solid annual rent increases of 1.5%, resulting in a GAAP cap rate of 6.4%.
Duration has value in the net rental world, or at least in recent history characterized by low inflation and low interest rates. The more than 19 years of life remaining on the first quarter acquisitions is a big reason why the initial capitalization rate was so low.
As we’ll see below, restaurants accounted for about half of Q1 acquisitions, while retail accounted for just over 1/3 and industrial 13%.
My first thought was that these newly acquired restaurants should be Quick Service Restaurants (“QSRs”) or fast food restaurants, as QSRs tend to trade at lower cap rates than casual dining restaurants. This would have explained the low weighted average acquisition cap rate of 5.7% for the quarter.
But this is not the case. Instead these restaurants were apparently high end restaurants (of unknown brands). Here is Czarnecki again with a commentary:
During the quarter, we acquired a portfolio of 16 high-end restaurants located in 10 different states, for a total of $100 million. These will include weighted average annual rent increases of 1.1% and a weighted average lease term of 19.5 years. The 16 sites were diversified through four different concepts and a master lease to a national operator with nearly 50 sites in total and over 30 years of experience. The assets are located in attractive retail corridors and display strong operating metrics that translate into strong rent-to-sales ratios and rental coverage.
And then there are the acquired commercial properties, which are mostly located in Canada, representing BNL’s first dip into the Canadian real estate market. Here’s Czarnecki again:
These retail transactions include our first targeted portfolio acquisition in Canada, which includes six high-quality retail locations leading to Canada’s leading outdoor recreation equipment retailer.
Last but not least, the two industrial properties acquired during the quarter. Czarnecki again:
Finally, we acquired two industrial assets and transactions for a total of $27 million during the first quarter. The leases include attractive weighted average annual rent increases of 2.1% and a weighted average lease term of 18.5 years.
The large sum of restaurants acquired during the quarter increased BNL’s total restaurant exposure from 13% at the end of 2021 to 15% at the end of the first quarter.
But industrial, which has become the hottest property type since industrial rents began to soar during the pandemic, remains BNL’s largest segment at 46%. This is the second highest exposure to industrial properties in the net lease REIT space, behind WPC with a 50% allocation (unless you count STAG Industrial (STAG), which exclusively owns industrial properties in single-tenant net rental).
This strong exposure to the industry certainly played a big role in BNL’s impressive rent collection statistics in 2021, posting 100% from the second quarter.
Also notice from the image above that almost all of BNL’s leases contain built-in rent increases, 13% of which are also linked to the CPI. This positions BNL slightly better against inflation than the average net rental REIT, although it is not as well positioned as WPC with 58% of its contractual rents linked to the CPI.
What about rising interest rates? At present, debt markets appear increasingly hostile to net borrowing by rental REITs, as bond yields have risen since the start of the year when there is no sign yet. capitalization rates begin to follow them upwards.
Fortunately, BNL has very little debt maturing this year or next year and relatively little maturing before 2026.
BNL benefits from an Investment Grade (BBB/Baa2) rated balance sheet and a modest net debt to EBITDA ratio of 5.1x. This is lower than WPC’s net leverage ratio of 5.5x, although WPC leads BNL in its weighted average interest rate: 2.5%, compared to 2.7% for BNL. Admittedly, both are extremely weak.
BNL has $788 million in total liquidity between $54 million in cash and $734 million in availability on its credit facility, which should largely contribute to the financing of acquisitions in the coming quarters.
Finally, the quarterly dividend of $0.27 represents a payout ratio of 77% based on a Q1 AFFO per share of $0.35. The annualized dividend also represents 77% of the AFFO 2022 forecast per share.
When I look through BNL’s portfolio and balance sheet, I can’t find much to complain about. I don’t care about office exposure, but it’s only 8%, and WPC has a much larger allocation for this type of property. And I also don’t particularly care about casual/fine dining restaurants, as these often lack corporate guarantees for their franchise operators, they are less resilient to recession than QSRs and labor shortages implemented have made it difficult for operators to remain complete.
Moreover, I am afraid that BNL is finished-diversified – jack of all trades but master of none. Management is certainly not equally adept in the areas of auto detailing, animal health facilities, call centers, and cold storage. This causes me a degree of uncertainty as to how BNL would fare during a non-pandemic recession.
That said, BNL’s strong pandemic-era rental collection statistics speak for themselves, showing that at least during that type of slowdown, the portfolio held up well.
Even so, due to the focus on industrial and essential retail in current acquisitions, I prefer WPC over BNL at the current price. Although WPC’s payout ratio is slightly higher, so is its dividend yield of 5.43%, compared to BNL’s 5.39%.
Also, WPC has a significantly higher share of CPI-related rent increases than BNL, which I think will prove a very valuable difference between the two over the next few quarters (and possibly years) . WPC’s first-quarter same-store rent growth was 2.7% and is expected to remain above 2% for some time to come.