In the wake of the housing meltdown and Great Recession, many large banks that were burdened with bad loans and heavy leverage, cut back on lending. For midsize businesses that typically have no credit ratings and are frozen out of bond markets, the loss of bank credit was especially vexing.
But for Chief Executive Christopher Volk and his co-founders of the real estate investment trust (REIT) Store Capital ( STOR ), it all added up to a prime business opportunity. Why not seek out mid-market companies that need capital, buy their real estate and then lease it back to them?
A win-win, if everything is properly handled. The unrated midsize companies -- typically operating restaurants, movie theaters, health clubs and furniture stores -- would free up capital by selling real estate. And by picking solid companies that were turning a profit, Store Capital could assemble a portfolio of reliable long-term leases.
Store Capital built a direct sales force to go out and find purchase and lease-back targets. It looked for companies that were operating successful locations but lacked the credit rating that would allow them to access bond markets.
"These are the people that need us," Volk told Investor's Business Daily.
And Store Capital seeks out locations that produce profit.
A FedEx ( FDX ) distribution center would not qualify, said Volk, because it is a "cost center." Store Capital wants to buy the locations that are actually bringing in cash.
"Our focus is really on the unrated middle market and larger business. Just to own the profit center," Volk said.
The strategy has been working. Last year, Store Capital acquired $1.2 billion worth of new properties, allowing it to grow revenue by roughly 50% over 2014 to just under $285 million.
And the purchase and lease-back strategy has been profitable, as Store acquired properties with a yearly return on capital -- or cap rate -- of over 8%. With his long history in the business, Volk has helped Store Capital borrow money and sell equity at an average cost of capital at 4.4% last year.
The difference between the return on capital and the cost of capital is known as the spread. In 2015, for Store Capital, the spread was 3.7%.
"Our spread last year was the best I've ever had in my life," said Volk, who has led real estate companies for three decades.
Analysts credit Store Capital's proactive style of seeking out investment and lease-back opportunities.
"They call and create the product," said Wunderlich Securities analyst Craig Kucera.
"They are working with tenants to show them the financial benefits of sale and lease-back," said Cowen & Co. analyst Michael Gorman. "These are tenants that aren't as well served by traditional sources of financing."
Of course, the Fed's suppression of interest rates has greased the credit wheels for many borrowers.
"Generally, when you have a long decline in interest rates, this space is one of the best performers," noted Kucera.
And the Fed, seemingly obsessed with fear that abrupt rate hikes might puncture the equity markets it has helped to inflate, shows little stomach for sustained tightening. Store Capital should be able to survive a modest pace of tightening, Volk contends.
"Even if rates go up, we should do fine," he said. He does allow, though, that a steep climb could pinch.
"When the 10-year Treasury was 6.5% it was much more difficult," he recalled.
Cowen analyst Gorman suggests one way that even relatively modest rate hikes would hurt. Right now, Store Capital pays a dividend of roughly 4% and is seen as a "yield play," he said. Rising rates would make other investments relatively more attractive.
The bigger risk for Store Capital would be tenant default, perhaps as the result of a major economic downturn. Roughly $2.4 billion of Store Capital's $4 billion portfolio serves as collateral for loans. So a massive wave of defaults could affect Store Capital's revenue stream and hence, its ability to pay back loans.
But that risk is offset to some degree by Store Capital's diversified portfolio, according to Kucera. No tenant comprises more than 3% of the portfolio, he noted. For his part, Volk says Store Capital would like to increase the weighting of unencumbered properties in its portfolio.
"We do plan to do that over time," he said.
Thus far Store Capital has had access to the capital it needs. And late last year, Fitch Ratings bestowed a BBB- rating on two Store Capital private placement offerings. That's an investment grade rating, though it is the lowest rung on the investment grade ladder.
On the positive side, Fitch cited Store Capital's "strong management team" along with its differentiated investment strategy and diversified portfolio.
But in releasing the rating, Fitch noted that the having all those collateralized assets could give the company incentive to "prioritize the encumbered asset pool."
For now, Store Capital seems to have discovered a market sweet spot that will continue to produce profitable opportunities. Volk says the firm has identified 70,000 potential targets that could benefit from its investment and services.
Could Store Capital again realize that 3.7% spread that marks the high point of Volk's three decades in real estate?
"It's possible to get close to that this year," he concluded.
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