Realty Income: Steady Performance Amidst Tenant Challenges

Realty Income(NYSE: O) has long been a favorite of income-oriented investors due to its monthly dividend, solid yield, and consistent dividend increases. Historically, the real estate investment trust (REIT) has provided steady results over the years.

Yet, with several tenants encountering challenges and closing storefronts, a crucial question arises: Is Realty Income facing difficulties?

Let’s explore Realty Income’s latest quarterly report, the security of its dividend, and the company’s strategy for addressing its struggling tenants.

Consistent Results in the Current Quarter

Realty Income reported a reliable quarter, though investor focus leaned toward the situation with its pharmacy, convenience store, and dollar store tenants. These sectors have encountered difficulties, with various companies under credit strain and closing locations.

Management discussed tenants who have gone through bankruptcy and emphasized their high recapture rates. With Red Lobster, Realty Income noted it managed 216 assets, out of which nine were rejected in court, achieving a 91% recapture rate. With Rite Aid, which recently exited bankruptcy, they realized an 88% recapture rate.

In the context of Walgreens and its store closures, Realty Income shared that all 13 lease renewals this year were completed, yielding a 100% recapture rate. Historically, the REIT has maintained over 100% recapture rates for lease renewals with CVS, Dollar Tree, and Family Dollar.

As of the quarter’s conclusion, Dollar General and Walgreens represented 3.3% of total annualized rent; Dollar Tree/Family Dollar made up 3.1%, and CVS stood at 1.2%.

Additionally, Realty Income is planning to establish a private capital fund aimed at leveraging opportunities in retail, industrial, data centers, and gaming sectors. This venture is intended to yield stable long-term capital while also generating recurring management fees.

In the third quarter, total revenue rose by 28% to $1.33 billion, driven by new properties acquired from the Spirit Realty acquisition in January and fresh investments. The same-store rental revenue saw a slight increase of 0.2%, and the occupancy rate remained high at 98.7%. During this quarter, Realty Income secured 170 lease renewals with a 105% recapture rate.

The REIT’s diversification strategy proved effective, as retail same-store rental revenue dipped by 0.3%, while industrial and gaming revenues grew by 1.9% and 1.7%, respectively. Notably, other properties, including data centers, experienced a 4.7% increase in same-store rental revenue.

Realty Income invested $740 million in new properties that quarter, achieving a 7.4% weighted-average cash yield. They also sold 92 properties for $249 million.

Furthermore, adjusted funds from operations (AFFO) per share rose by 3% to $1.05, a key measure of a REIT’s operational cash flow.

Realty Income raised the lower end of its full-year AFFO guidance to a range of $4.17 to $4.21, up from the previous $4.15 to $4.21. The company now anticipates investing $3.5 billion in new properties, an increase from the earlier expectation of $3 billion.

Image source: Getty Images.

Maintaining a Sustainable Dividend

Even with recent pressures on some tenants, Realty Income’s dividend appears secure and positioned for continued growth.

In the latest quarter, the REIT raised its dividend by 3% to $0.789, marking 108 consecutive quarters of dividend increases.

The dividend was well-supported by the $1.05 in AFFO generated during the quarter, resulting in a payout ratio of 75.1%. This strong coverage allows Realty Income room to further increase its dividend going forward.

Should Investors Consider Buying the Stock?

Realty Income stock encounters both challenges and opportunities currently. While the REIT is optimistic about recapturing lost rent from closures, it is essential to monitor the performance of Walgreens, CVS, Dollar General, and Dollar Tree/Family Dollar, collectively representing about 11% of its annualized contracted rent.

Conversely, a declining interest rate environment could benefit the stock and boost property values. Realty Income has faced challenges despite consistent results due to rising capitalization rates (cap rates) that diminish commercial property valuations. However, as the Federal Reserve lowers rates, cap rates are also declining, enhancing commercial property values.

In summary, the interest rate landscape may play a significant role in driving the stock’s performance in the future, as Realty Income has demonstrated an ability to navigate tenant credit issues and store closures in previous instances. Moreover, its venture into private funding appears likely to benefit the REIT and would be advantageous for potential investors considering the current dip.

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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Realty Income. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.