[Bank of America]
Incrementally better news since our last update in October
Incrementally news flow has become more supportive of the net lease REIT sub-sector. However, at this time we believe it is too early to signal the all clear for the sub-sector. Key incremental: (1) the Fed has signaled rate hikes are largely over and our Economists are now forecasting a rate cut starting in June 2024 (Global Econ Year ahead). As spread investors a lower cost of capital is supportive of earnings growth. (2) several net lease REITs have idiosyncratic earnings drivers in 2024 that do not rely on equity capital markets. For example, O's recently announced public-to-public M&A, ADC's ability to lever up, EPR's continued normalization post COVID (adjusting for deferral payments), and NNN's higher free cash flow as a percent of average annual acquisitions.
Cost of capital is the key driver of the net lease outlook
Ahead of earnings on October 10, we revised our estimates lower for the net lease sector and made several rating changes within the sector. Overall, we took a more bearish view on the net lease sub-sector as we updated our forward interest rate assumptions in our model to reflect the significant increase in debt and equity costs. We note that from 2Q earnings (August 1) to October 10, the 10-year Treasury increased from 4.05% to 4.66%. Since our note revising net lease REITs cost of capital, the 10-year has fallen to 4.41%. Given the volatility in the capital markets, we have not revised our interest rate assumptions at this time but incrementally a lower 10-year is a benefit to 2024 and beyond growth.
NL looks better on a relative basis vs other sub-sectors
EPRT and WPC both provided earnings guidance for 2024 with 3Q results. We view EPRT's 2024 guidance as conservative and are slightly above their 2024 AFFO range. WPC also provided 2024 guidance. Their AFFO earnings guidance range ($4.60-4.80) was below our prior BofAe of $4.89/sh. We attribute the weaker than expected preliminary guide to lower acquisition volumes compared to our expectation. Interestingly, several net lease REITs (NNN, O, EPR) at the recent industry conference (Nareit) pointed to mid-single digit earnings growth in 2024 without having to rely on the equity markets. We will be laser focused on their ability to achieve these targets given that on a relative basis net lease may screen better as other sectors continue to show earnings cracks.
Updating our POs and estimates post 3Q results
After updating our model for 3Q results, our POs and estimates change. Briefly our PO for ADC goes to $60 from $58, EPR to $47 from $41 EPRT to $25 from $23, NNN to $37 from $35, for O to $55 from $52, finally we lower our PO for PKST to $10 from $12. See Exhibit 22 for the estimate changes.