Spirit Realty Capital (SRC) is a net lease REIT with a 7% yield and trading at a significant discount to fair value.
SRC's recent results have been positive, with boosted guidance for adjusted FFO per share.
The company has good diversification, long lease lengths, and strong tenant quality, making it an attractive investment option.


It's Spirit Realty (SRC). The REIT now yields a meaty 7%, while also trading at a significant upside to its historical valuation.

Let's see what this REIT can offer us at this time.

Spirit Realty Capital - Plenty to like about undervalued triple-net
Investment-grade REIT investing with a 7% well-covered yield is not possible in every market environment, but it seems positive in this one.

By well-covered, we mean that the FFO payout is less than 75% on a 2023E current basis, and that's including a one-percent FFO drop at this time.

The latest results from Spirit Realty Capital we currently have are the 2Q23 results - and these were of a positive nature.

How so?

A consensus-meeting set of results from August 8th isn't exactly perhaps the best explanation for why this REIT is such a superb "BUY" - but we really have to consider in context, just how good this is given the expectation of an FFO drop we had before this prior quarter.

This quarter, after all, caused SRC to boost guidance.

The company is now expecting 2023 adjusted FFO per share of $3.56-$3.62, compared with its previous guidance of 3.54-$3.60 and the $3.65 consensus.

(Source: Spirit Realty Capital Earnings, 2Q23)

This means that we might only go down less than a percent for the year - or perhaps not even at all, which of course would be excellent given the past few years of trends.

SRC is doing what most REITs are doing in this segment. Disposing of underperforming or non-core assets at preferably appealing cap rates, while investing in better assets to enhance its portfolio.

SRC IR
SRC IR (SRC IR)

The company's capital has been going more and more towards industrial properties since 2022, but entertainment retail is seeing a bit of a climb as well, as well as overall retail.

There's a significant fundamental quality to be had here when looking at SRC, as I've pointed out in the past. It has good diversification, with good tenants in its ABR. It has very little overexposure to any one area, which other REITs do not share in terms of quality.

The company also, unlike some of its peers, has an extensive average lease length, of over 10 years, which is very good in the context of net lease. The average size of an SRC asset is just above 100k sqft.

What was once rent collection issues during COVID-19 are now completely gone.

Rent payments are in full - and there are plenty of good tenants to like here. As of 2Q23, the ABR for the full year is nearly $700M from 2,064 properties that the company owns at a near-market leading occupancy rate of 99.8%. Out of that, over 86.5% of all tenants are at over $100M in revenues.

The company has, as such, very few "small players" in its portfolios, and these tenants hail from almost 40 industries and are almost 350 in number from 49 states in the US.

The one disadvantage we see to the company's rent base is continued exposure to Walgreens (WBA) well above where other REITs and other companies we look at an invest in are seeing exposure.

3.8% of the company's ABR comes from Walgreens, and given the state of the pharmacy, that's not something we particularly care for. We don't see a non-payment risk, but we do see a risk of the company needing to release these properties.

But aside from those, the remaining industries and tenant diversification are absolutely solid.

The company also very recently raised its quarterly dividend, in defiance of all those that seek to doubt it. Though before we cheer in joy from that, remember that the raise was only 1% - so it's more of a token raise than anything else.

Still, the company would not have done a token raise if the results weren't at least acceptable, and these 2Q23 results were anything but.

Spirit Realty is treated, on the market, as markedly different than some of its peers, most specifically Agree Realty (ADC) and Realty Income (O).

While the company does have key differences both in terms of size and in terms of safety, we argue that these differences are far from as significant as to justify what we're seeing on the market today.

The company has been growing its industrial asset portfolio.

This is part of the argument why SRC, going forward, might make even more sense to invest in than some of the other triple-nets, because many of these properties are newer, with better leases, and more mission-critical in their application than even some of the wholesale anchors and large stores/other properties the company otherwise operates.

Perhaps the second risk or disadvantage to SRC is the fact that only a small number of the tenants have CPI-related rent escalators, with most at over 77% at contractual escalations.

This might not sound bad, but keep in mind that most of these escalations were decided when we did not have the current inflation, meaning they're likely significantly below current CPI numbers.

Instead, point to the other positives - such as occupancy, which for several years has not dropped even slightly below 99%.

Instead, point to the company's credit safety - BBB rated, with no sign of declining. The company is still forecasted, at least by FactSet analysts, to deliver an FFO drop of around 0.9%.

If you believe that is enough why this company should trade at only 10-11x P/FFO, while peers trade at almost twice that, then we would say you're being too harsh on the company, despite a 3-year growth prospect of only 1% per year on average.

We believe the valuation coupled with what we're seeing here in terms of an overall lack of FFO decline makes the case for investing here.

Oh, we could see further drops - but that would just make it more appealing to invest here.

Let's look at the thesis for investing, and what you could make by investing in Spirit Realty today.

Spirits Valuation - a 15%+ Upside annually is very much possible.

So, as you know, we look for 15%+ annualized upsides - and they need to be conservative, not based on valuations the company has never seen before. When it comes to Spirit Realty, we see 9-13x P/FFO trends, which means we don't want to put it at the level of O or ADC.

Fortunately, we don't need to do that to get a 15% annualized upside.

All we need to do for that is to expect the company to trade at 12.5x P/FFO within 3 years. If it does that, the combined yield and reversal, despite almost no growth, will deliver that return here.

Is it likely?

That depends - we believe it is, as we believe the market will see a reversal.

But we could also see a deepening undervaluation in REIT space - even more than we already have. That would of course potentially see lower returns, or enable us to invest at even cheaper valuations, should we choose to do so.

In the end, though, we believe investors need a reminder of what SRC is. Namely, it has key exposure to most geographies we want, while avoiding or having lower exposure to geographies we may want to avoid.

That means it's not just a play on REIT space, it's also a play on urbanization, movements of people (as we're seeing), and demographics, all of which trend towards the favorable as things are looking now.

This momentary weakness in the space is nothing that causes us to hesitate. If anything, the current unfavorable FX we are personally exposed to causes us to hesitate more than any specific downturn in REIT space.

We last wrote about Spirit Realty was around 2 months back. And we were positive, and we bought more. We also set a price target at $40/share, and despite what we're seeing here, we’re not discounting or lowering the price target.

S&P Global analysts is forecasting the company even loftier targets than us. 15 analysts go from a low of $40/share to a high of $58/share, with an average for $44/share.

Despite the current share price, which is actually below the lowest possible PT, 11 analysts out of 15 have a "HOLD" rating at this time, a remarkable lack of conviction and clarity with respect to these targets.

We believe that the combined yield and upside are more than worth it, and SRC is very much worth consideration even in the context of the many opportunities available on the market today.

What we want to make sure of is that if you consider this, you consider diversifying into a number of investments with a 15%+ annualized upside - diversification.

Risk reduction is what we’re looking for at this time, and as much as ADC and O investments are part of this, our SRC position is part of this as well.

Spirit Realty offers some of the best companies out there, some of the most recession-resistant businesses, and space that's been leased on average for over a decade into the future. Even in the case of a slight FFO decline, this portfolio is more than likely to continue outperforming.

We expect REITs, especially triple-net and net lease REITs to bounce back at the end of the rate hike cycle. While we can argue back and forth about where in the cycle we are, we would say it's likely that we're closer to the end than to the beginning.

The key is finding the REITs that drive shareholder value due to lower cost of capital, better growth, and higher portfolio quality. It's our firm conviction that SRC is one such REIT, and we both back this up by investing in it.