How are Triple Net Leases and REITs Linked?

Triple net leases are often the result of a real estate sale and leaseback arrangement. A retailer like Home Depot (NYSE: HD), which both owns and occupies its own locations sells the property to a REIT or other investor. It sweetens the sale by agreeing to a long-term lease with the REIT on a triple net lease basis.

It's a win-win deal -- the company gets cash up front while the REIT and its shareholders get a predictable income stream.

For example, Omega Healthcare (NYSE: OHI) specializes in sales/leaseback arrangements. It buys properties owned by healthcare providers and then turns around and leases them back to those companies. That frees the healthcare providers from the hassles of managing real estate while also allowing them to monetize their asset. Meanwhile, the arrangement gives REITs like Omega a reliable rental stream, which generates solid investment returns.

Although rents do tend to be lower in triple net leases, expenses are also lower, and many of the arrangements also call for annual rental increases as a hedge against inflation. Another benefit of triple net leases is they generally allow a REIT to establish a line of credit on more favorable terms since they are backed by secure earnings.

Most triple net leases are held by healthcare and other REITs that operate out of single-tenant, free-standing buildings. The downside to these single-tenant leases is the risk that the tenant runs into trouble and can no longer afford to pay the rent. However, these REITs typically hold a diverse portfolio of real estate assets that limits their exposure to any one tenant. Omega, for instance, owns some 240 healthcare facilities operated by dozens of different providers in 30 states across the U.S.

Why Invest in REITs

Most investors buy REITs for their rich REITs. REITs typically deliver annual dividend yields of between 6% and 7%--three times more than the average 2% yield paid out by the 374 dividend-paying stocks in Standard & Poor’s 500-stock index (S&P 500). Just be aware that since most REITs don't pay income taxes, their dividends are usually fully taxable.