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Better Buy: Realty Income vs. National Retail Properties

Matthew Frankel, CFP, The Motley Fool

Realty Income (NYSE: O) and National Retail Properties (NYSE: NNN) is about as natural of a comparison as you can get. Both companies are REITs, both specialize in freestanding single-tenant retail properties, and both use a net-lease structure with their tenants to maximize predictability.

With that in mind, here's a rundown of some of the key differences between these two rock-solid REITs, and a look at which could be the better buy now.

Shopper picking out groceries.

Image source: Getty Images.

A bit more about what these companies do

As I mentioned, both companies specialize in freestanding net-lease retail properties. If you aren't familiar, a net lease (also known as a triple net lease) is a common type of leasing arrangement for single-tenant commercial properties. Essentially, these leases require the tenant to pay for property taxes, building insurance, and most maintenance expenses -- the variable costs of property ownership.

This is a desirable arrangement from an investor's perspective for two main reasons. First, a net lease shifts the fluctuating costs to the tenant. If a property's taxes double from one year to the next, it doesn't affect the REIT's income. Second, net leases generally have long initial terms with annual rent increases built in. So, a net lease provides predictable, increasing income for years.

The biggest difference between the two investment strategies

While the focus of these two REITs is the same, there are some key differences investors should know. We'll start with the property portfolios.

Realty Income is the larger of the two, with about 5,700 properties in its portfolio, compared with about 2,850 for National Retail Properties. However, the biggest difference isn't the size.

The main distinction between the two companies is the diversification of properties. While both REITs specialize in retail properties, National Retail Properties is a pure play on freestanding net-lease retail. In other words, that's all the company invests in. In Realty Income's case, non-retail property types -- specifically office, industrial, and agricultural -- make up about 20% of the portfolio.

Tenant mix

There's quite a bit of overlap between these two REITs' portfolios, as you might imagine. For example, convenience stores are the largest component of both companies' rental income. However, there are a few key differences. National Retail Properties has a slight focus on hospitality and service-based tenants -- 20% of the portfolio is restaurants; automotive service centers make up about 8%; and another 6.5% is family entertainment centers. On the other hand, Realty Income has a higher concentration of discount and nondiscretionary retail, such as drugstores and dollar stores.

To give investors a better idea of the two portfolios, here's a comparison of each REIT's 10 largest tenants:

Tenant Rank

Realty Income

National Retail Properties

1

Walgreens

7-Eleven

2

7-Eleven

Mister Car Wash

3

FedEx

Camping World

4

Dollar General

LA Fitness

5

LA Fitness

GPM Investments (convenience stores)

6

Dollar Tree/Family Dollar

AMC Theatres

7

AMC Theatres

Couche-Tard (Pantry)

8

Walmart/Sam's Club

Taco Bell

9

Circle K

Sunoco

10

BJ's Wholesale

BJ's Wholesale

Data sources: Realty Income and National Retail Properties.

As you can see, there's a considerable degree of overlap. Only Realty Income's portfolio skews toward the traditional retail side, while National Retail Property has more of a service-oriented focus.

Dividends: Past, present, and future

Both of these REITs have fantastic dividend track records. Realty Income pays monthly dividends and has made 581 consecutive payments. Since its 1994 NYSE listing, the company has increased the payout 99 times. National Retail makes quarterly dividend payments and has 29 consecutive years of increases.

As far as yields go, Realty Income's and National Retail Properties' dividends translate to 4.4% annualized yields. It's tough to declare a winner in this category.

Valuation

As is often the case with similar investment vehicles, valuation can be a good way to try to pick the better option. For REITs, one smart way to compare valuations is to look at each company's price-to-FFO multiple.

Metric

Realty Income

National Retail Properties

Share price (12/26/18)

$60.65

$46.00

2018 FFO guidance (midpoint)

$3.195

$2.64

P/FFO

19.0

17.4

Data source: Company press releases. Adjusted or normalized FFO projections are used when available.

The verdict

To be perfectly clear, I don't think investors can go wrong with either of these REITs as a long-term investment. Both should continue to provide steadily growing income and excellent total returns for the foreseeable future. Realty Income is currently one of my largest stock holdings, and I have owned National Retail Properties in the past.

Having said that, if I were going to buy (or add to) one today, I'd choose National Retail Properties simply because of its slightly lower valuation.

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Matthew Frankel, CFP owns shares of FedEx and Realty Income. The Motley Fool owns shares of and recommends FedEx. The Motley Fool recommends Camping World Holdings. The Motley Fool has a disclosure policy.