Realty Income REIT Making Moves Into European Net Leasing

Realty Income Corp. O is one of the world's largest public REITs, but you may not have heard of it because of the sector it operates in. Realty Income holds one type of asset: properties with net leases. After steadily building a portfolio worth over $40 billion in U.S. assets, Realty Income is taking its show on the road to Europe. 

The move into Europe began in 2019 when Realty Income acquired a large tranch of grocery stores in England. Now the REIT is looking to Europe for even more opportunities. The reason for the move is twofold: First, a REIT the size of Realty Income, which has 13,000 assets, can't buy one or two properties at a time and see a noticeable increase in investor return. Second, in addition to having an abundance of available assets, the European commercial market is not dominated by net leasing. 

What this means for Realty Income is that there is tremendous profit potential in acquiring European assets and converting them to net leases. The profit potential is even higher because of the lack of competition for assets in comparison to the U.S., where multiple net-lease REITs are always looking for new acquisitions. Here is why investors should pay attention to this move.

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Net Leases Are Ideal Arrangements For Investors And Property Owners

In a net lease, the tenants of a property — usually commercial — pay rent for their space, along with a prorated portion of the owner's operating expenses. Net leases have numerous potential configurations that range from tenants being responsible for a prorated portion of the owner's insurance, property taxes or maintenance costs. Each of the expenses paid by the tenant results in that cost being net profit for the property owner. 

The amount of the net contribution made by a tenant in a net lease is usually determined by the size of the space it is renting in relation to the entire property. The larger a space is, the bigger share a tenant will pay for whatever net expense is laid out in the lease. In a single net (N) lease, the tenant may pay one expense, which will be specified in the lease contract. Most large commercial spaces operate on what is known as a triple-net lease. 

In a triple-net lease (NNN), the tenant is responsible for paying a prorated share of all the insurance, property taxes and maintenance along with its rent. Needless to say, contracts like this are favorable to the property owner and investors. A property that doesn't have to make deductions for property tax, maintenance and insurance will almost always have a higher net operating income (NOI) than a property with a tenant on a standard lease. 

Why Is NOI So Important For Commercial Property Investors?

NOI is a key metric for property investors because the value of a commercial property is heavily determined by its NOI. This is a direct contrast to a property on a standard lease, whose value is based mainly on what similar properties are selling for at a given moment in time. Additionally, NNN leases tend to have longer terms and fixed rent increases designed to phase in throughout the term.

Both of those factors make NNN properties recession-resistant in comparison to other assets. Even in a down market where real estate values might be expected to take a hit, a commercial asset with strong NNN tenants is much more likely to retain, if not increase, its market value. That's all because those net leases are pumping out reliable returns for investors. These reliable returns are what determine the value of the asset. 

Net REIT Earnings Offer Hedge Against Inflation

The same factors that make net lease properties resistant to market forces also make them great hedges against inflation. The built-in rent increases in many net leases are usually tied to a benchmark, such as the standard overnight finance rate (SOFR) or consumer price index (CPI).

If these benchmark rates increase during periods of high inflation, net lease investors have increased protection because the collected rents will go right along with the benchmark. Another benefit is that the steadily increasing nature of the NOI, thanks to the rent increases, means that the assets are appreciating as well. 

Another tremendous advantage of net REITs like Realty Income is that they can raise capital to acquire assets without having to borrow money — or as much money — as other REITs. When you consider that current interest rates are in the 7% range, the potential benefit of raising capital without borrowing speaks for itself. 

You Can Invest In Net REITs Or Other Passive Income Opportunities

Realty Income has been quietly delivering reliable returns for its investors for nearly three decades. It's delivered an increased dividend for 29 years through a slow, steady growth approach. It will move into Europe with caution and, more importantly, with a long-term growth plan. This will not necessarily be an asset spree where they go on a binge and buy commercial assets all over Europe. 

There is a lot to learn from this approach when it comes to passive income and generating long-term wealth, but you don't have to be a heavy hitter to do it. Shares of Realty Income are trading around $50, and you have a full menu of other publicly traded REITs in a variety of sectors to choose from. You can also build your portfolio through real estate crowdfunding platforms. 

Considering the strong history of returns associated with real estate investing, it's a sector worth a long look from investors. That doesn't mean it's a guarantee, but buying into a REIT that consists of institutional or commercial tenants on net leases might be an excellent way to diversify your portfolio. 

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