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Realty Income: All-In After Spirit Realty Capital Merger

Realty Income: All-In After Spirit Realty Capital Merger

Realty Income Corporation (NYSE:O) recently announced its acquisition of real estate investment trust Spirit Realty Capital Inc. (SRC), causing a surge in the target’s stock price by 8%. While Realty Income’s stock price fell by 6%, this is a common occurrence when the acquirer carries all the transaction risk.

The $9.3 billion acquisition of Spirit Realty Capital is a strategic move for Realty Income, aiming to strengthen its core retail business and expand its industrial operations. Additionally, it is anticipated to result in a 2.5% increase in AFFO (Adjusted Funds From Operations) per share.

This compelling FFO (Funds From Operations) multiple of the Spirit Realty Capital transaction provides an excellent opportunity for passive income investors to consider Realty Income after the merger announcement.

My Rating History

Realty Income’s previous investment in the Bellagio marked a significant step forward in diversifying its FFO streams into the gaming industry. The acquisition of Spirit Realty Capital further solidifies the trust’s diversification profile and positions Realty Income as the 4th largest REIT in the S&P 500.

Why Is Realty Income Acquiring Yet Another Multi-Billion Dollar Trust?

Realty Income has a track record of making major acquisitions to drive FFO growth. The $9.3 billion all-stock transaction to acquire Spirit Realty Capital strengthens Realty Income’s existing core retail operations while also adding a considerable number of industrial properties to its portfolio.

Although Realty Income has a background in retail real estate, it has been investing heavily in industrial real estate since 2010, with industrial operations now accounting for 13% of annualized contractual rent. The acquisition of Spirit Realty Capital, anchored in retail but with a significant industrial property portfolio, incrementally diversifies Realty Income’s real estate holdings.

Spirit Realty Capital owns 2,064 properties, including 257 industrial properties. With a lease rate of 99.8%, this transaction is expected to improve Realty Income’s pro-forma portfolio occupancy to 99.1%. Moreover, Spirit Realty Capital’s industrial properties, valued at $2.5 billion, are split between manufacturing and distribution facilities.

Realty Income has a higher percentage of investment-grade tenants compared to Spirit Realty Capital (40% vs. 19%). However, SRC has a higher weighted average lease term of 10.3 years compared to Realty Income’s 9.6 years.

Immediate Benefits Of The SRC Acquisition

The acquisition of Spirit Realty Capital brings immediate benefits to Realty Income. The expected synergy effects will result in a reduction of $50 million in annual run-rate costs. Furthermore, the transaction is estimated to lead to a decrease in the trust’s G&A expense ratio from 3.9% to 3.5%.

Importantly, the transaction is projected to achieve immediate AFFO accretion potential of over 2.5% per share, without impacting the trust’s leverage structure. This acquisition enhances Realty Income’s portfolio diversification, weighted average lease term, and strengthens its non-core real estate holdings.

Realty Income Is A Steal Below $50

Realty Income’s current stock price of $46.22 offers a bargain AFFO multiple of 11.7x. Compared to its past valuation of 20x AFFO, the current price presents an attractive opportunity for investors. It is worth noting that Realty Income’s acquisition of Spirit Realty Capital further validates this valuation, as SRC is valued at 9.7x AFFO following the deal announcement.

Considering Realty Income’s guidance of $3.96 to $4.01 per share in AFFO, the trust’s stock is undervalued. Additionally, other REITs such as Kimco Realty Corporation (KIM) are trading at an 11.0x FFO multiple, providing additional context for Realty Income’s attractiveness.

Why Realty Income Might See A Lower/Higher FFO Multiple

Realty Income’s performance is dependent on the retail sector of its property portfolio, making it susceptible to the risks of a recession. Higher interest rates could also pose a challenge, increasing the costs of real estate transactions and (re)financing for REITs with floating-rate debt. However, Realty Income has demonstrated resilience in the face of such challenges over the years.

My Conclusion

As a long-term holder of Realty Income’s stock, I consider it to be a core holding in a passive income portfolio due to its stable dividend pay-out and long-term dividend growth history. The recent acquisition of Spirit Realty Capital further enhances Realty Income’s AFFO and strengthens various non-core FFO streams, positioning it as an attractive investment opportunity.

At its current valuation, Realty Income presents a compelling option with a high-quality 6.6% yield. This all-in opportunity warrants a Strong Buy.