Behold the stock market, a champion in its own right, boasting a 15% rise (as per the S&P 500) this year. But let’s not forget—the “Magnificent 7” mega-cap stocks have been running the show. The rest of the market, a faction fraught with struggles and strife, is also mirrored in the REITs world. And right there, at the heart of this tempest, sits Realty Income, the popular monthly-dividend REIT (NYSE:O), down by a heavy 15% this year. Brace yourselves as we delve deep into the storm-stricken realm of Realty Income, pitting it against over 100 other colossal-yielding REITs, sifting through industry-specific adversities, plummeting valuations, and emerging victoriously as the chosen one.
Realty Income, recognized fondly as “The Monthly Dividend Company,” is a real estate investment trust (“REIT”) with an illustrious history of bestowing monthly dividends for over 54 years, which have burgeoned steadily over time. The company’s coffers swell from a colossal portfolio of over 13,250 properties, predominantly held under long-term net lease agreements with commercial (primarily retail) clients. Here’s a peek into Realty Income’s esteemed top 20 clients:
100 Big-Yield REITs, Compared:
Before diving deeper into Realty Income, let’s take a step back and ponder over Real Estate Investment Trusts (“REITs”) in general. As you know, to qualify as a REIT:
“a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.”
The big dividend yields adored by many REIT investors are an offshoot of this. Furthermore, as revealed in the table below, REITs span across various industry groups like “retail,” “industrial,” “mortgage,” and “office,” each facing its tribulations. While REITs at large have been through the wringer, some sectors have emerged bloodied and bruised, with the office properties sector facing an especially grim reality amidst the lingering “work-from-home” paradigm.
(CCI) (DLR) (IRM) (SPG) (PLD) (STAG) (PLYM) (NLY) (STWD) (AGNC) (WELL) (VTR) (OHI) (MPW) (WPC)
With this backdrop, let’s delve into the specifics of Realty Income.
Realty Income’s Business Strategy:
Realty Income’s current strategy revolves around growth through acquisitions, steering toward a destiny where it will soar as the fourth-largest US REIT, armed with its latest hefty acquisition (of Spirit Realty(SRC)) expected to bear fruit in the first quarter of 2024.
This acquisition strategy stands on two pillars. Firstly, propelled by economies of scale and a robust credit rating, Realty Income leverages lower acquisition costs compared to its peers, a compelling competitive edge. Secondly, the strategy capitalizes on the immensely fragmented market, promising a plethora of alluring opportunities.
Current Macro Environment
In a world where interest rates have soared to new peaks over the past two years, as the Fed rages against the flames of high inflation, property owners find themselves grappling with escalating costs to finance property acquisitions and refinance existing loans. Nevertheless, Realty Income, with its lower cost of capital, is perched on a distinct precipice, affording it a precious advantage over other REITs. Additionally, Realty Income’s “net lease” strategy positions it adeptly to navigate the storm of rising rates.
Secular Changes in Retail Real Estate
Secular changes are casting a formidable shadow over the REIT landscape, with the internet dramatically altering the retail REIT paradigm as consumers pivot toward online retail. While Realty Income predominantly holds retail properties, it has strategically sought opportunities less susceptible to the sway of internet retail. Despite this, the company remains affected. However, its property selection affords it a fortuitous position against the tide faced by fellow REITs.
The allure of Realty Income lies in the unwavering faith investors hold in its steadily burgeoning monthly dividend.
From a dividend safety perspective, the current quarterly dividend (on a forward basis) stands at $0.77 per share, a hefty cover for Realty Income’s Funds From Operations (“FFO”) of $1.04 per share. The dividend also boasts solid coverage against Adjusted FFO of $1.02 per share. Moreover, the growth in funds from operations has remained fairly consistent over time, a reassuring sign, as depicted in the chart below.
From a valuation standpoint, Realty Income currently trades at 12.8 times AFFO, marking a dip from its historical standards. The share price tumble contributes to the lowered P/AFFO ratio, all while the FFO stands solid, as evident in the chart below.
Furthermore, the current dividend yield offered by Realty Income is nearing 6%, a highlight by historical standards compared to the long-term target of 4-5%. This lofty dividend yield signals management’s belief in the shares being undervalued, projecting a mathematical return to normal yields when the share price eventually climbs, drawing strength from past occurrences.
The ominous specter of rising interest rates looms over the entire real estate domain, presenting a gory spectacle of heightened expenses and formidable investment challenges. Yet, Realty Income stands fortified, with economies of scale, a robust balance sheet, and lower borrowing costs tipping the scales. However, as others struggle, Realty Income’s growth may face obstructions in the future.
Sales-Leasebacks are rising in popularity, a trend benefiting Realty Income, where property owners, shackled by insurmountable interest costs, find solace in offloading properties to seek liquidity. These transactions, a temporary salve, mirror the lingering distress in the real estate realm.
Overconfidence emerges as a menacing adversary, as management and investors revel in the company’s storied performance, often teetering on the edge of complacency. Yet, as history is testament, past glories scarcely herald future successes, paving the path to disillusionment.
Further still, Realty Income’s continued concentration in retail properties, despite forays into industrial properties, presents persistent concentration risk, exacerbated by the ongoing upheavals in retail, as earlier detailed.
The Bottom Line
Despite the tempest, Realty Income stands as a beacon for income-focused investors seeking a potential for appreciation. With an impressive dividend yield, well shielded by AFFO, along with a historically low valuation, we see Realty Income’s “growth through acquisition” strategy as a prudent compass, charting the path for the strongest REITs, with Realty Income at the helm, to weather the industry disruptions and emerge victorious.
We are proud bearers of Realty Income shares in our Income Equity portfolio, prophesizing a future of soaring share prices and dividends. In fact, Realty Income has been hailed #10 on our list of Top 10 Big Yields (just trailing PDO at #9 and DPG at #7).