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Consider Equity REITs for Your Next Investment: Realty Income, Inc.

Published March 12th, 2018 by Dirk S. Leach

I recently wrote an article for Sure Dividend entitled “Consider Equity REITs for Your Next Investment“.  In that article, I listed nine equity REITs for dividend investors to consider in light of the drubbing that REIT valuations have recently taken due to fear of rising interest rates and to capitalize on the pass-through provision for REIT income included in the new tax legislation.  Both of these topics are covered in some detail in the previous article.  This article provides a more complete investment thesis for Realty Income (O), one of the nine REITs highlighted in the previous article.

Realty Income, Inc. 

Realty Income is a triple net lease REIT with holdings in the retail, office, industrial, and farmland space plus some relatively small holdings in mortgage loans.  Realty Income was founded in 1969 and went public on the NYSE in 1994 and has an enterprise value of roughly $22B today.

For those readers not familiar with triple net leases, also known as NNN (not to be confused with the ticker symbol NNN), it is a contractual relationship where the tenant is responsible for property taxes, insurance, and maintenance costs.  In fact, Realty Income has a number of different attributes compared to other more typical retail space REITs as the chart below shows.

Realty Income Differentiated Business Model

Source:  Realty Income Investor Website

The differences are significant and provide Realty Income significant business advantages over typical retail space REITs.  These advantages have resulted in a significant performance advantage over most other retail space REITs.  The chart below shows Realty Income’s performance and volatility compared to major market indexes.

Realty Income Volatility and CAGR

Source:  Realty Income Investor Website

Not many stocks can offer index beating total returns with lower overall market volatility and it is worth noting that performance has been over a period of more than 20 years.

The REIT is pretty well known in the investment community and has adopted the unofficial moniker of “The Monthly Dividend Company” because it pays out its dividend distribution on a monthly basis.  I’ll cover it in a bit more detail further into the article but it is worth noting that Realty Income has raised its dividend for 81 consecutive quarters.  That is more than 20 years of increasing the dividend every three months.  Realty Income has raised its dividend at least every year for more than 25 years.  The chart below shows Realty Income’s annual dividend growth since being listed on the NYSE in 1994.

Realty Income Dividend Track Record

Source:  Realty Income Investor Website

Dividend growth like this is pretty impressive and it readers should appreciate how much those annual dividends (paid monthly) matter for total returns.  The next chart shows Realty Income’s total return including reinvested dividends from 1994 through September 2017.

Realty Income Dividends Matter

Source:  Realty Income Investor Website

Readers should note that Realty Income not only beat the S&P 500 Index with reinvested dividends, it also beat the index without dividends being counted.  How many low volatility stocks can claim similar performance?

Realty Income has a very well diversified portfolio of properties.  As shown in the chart below, Realty Income has the majority of its properties in general retail followed by office space, industrial space, and farmland.

Realty Income Property Type Diversification

Source:  Realty Income Investor Website

At first glance it might seem that Realty Income is not diversified with most eggs in the retail space.  A look at Realty Income’s tenant list shows that it is very well diversified.

Realty Income Tenant Diversification

Source:  Realty Income Investor Website

The chart above shows that no single retailer is responsible for more than 6.5% of Realty Income’s revenue and most are well below that level.  The REIT also has geographic diversity with properties in 49 states plus the Commonwealth of Puerto Rico.  The chart below shows Realty Income’s revenue percentage per state.

Realty Income Geographic Diversification

Source:  Realty Income Investor Website

The REIT has also been able to maintain high occupancy rates across its properties to the benefit of its investors.

Realty Income Solid Fundamentals

Source:  Realty Income Investor Website

Occupancy rates having never fallen below 96.7% and consistent same store rent growth have allowed Realty Income to produce those index beating returns discussed earlier.

Obviously, Realty Income has been running consistent and steady over the long term, akin to a finely tuned Swiss watch.  However, I would be remiss if I didn’t discuss Realty Income’s capital structure and balance sheet.  The chart below provides a good summary of both.

Realty Income Capital Structure

Source:  Realty Income Investor Website

Realty Income relies more heavily on equity capital than it does on debt by a factor of more than 2.6x.  This conservative approach to its capital structure has earned Realty Income strong investment grade credit ratings from the rating agencies.

Realty Income’s Recent Financial Performance 

Realty Income’s most recent performance remains solid.  The REIT’s AFFO continues to grow, its dividend continues to grow, and its dividend coverage remains solid.  The charts below show both AFFO and dividends for the last 4 years plus a projection for 2018.

Realty Income AFFO Growth and Dividend Growth

Source:  Author

With strong AFFO growth, Realty Income’s dividend/AFFO payout ratio is slowly decreasing as the chart below shows.

Realty Income Payout Ratio

Source:  Author

The ability to continue to grow the dividend while lowering the payout ratio is strong indication that the REIT is healthy.

Realty Income Investment Thesis

Realty Income’s latest quarterly report (4Q17) wasn’t stellar as they missed analyst’s projections for FFO by $0.04 with revenue essentially inline.  That miss, combined with investor fears over interest rate increases, brought the REIT’s price down to a range below $49 per share and its dividend yield above 5%.  That is bargain territory and bargains don’t generally last very long.  Indeed, Realty Income’s stock price has partially recovered to a level above $50/share.

While the market has pushed REIT valuations down over the last couple of quarters, and particularly the past month, due to fears of rising rates, history tells us that REITs generally do well during periods of slowly rising rates and some REITs will often beat the big market indexes under these conditions.  This is particularly true for REITs like Realty Income since the economic conditions that are causing the Fed to tighten monetary policy will also increase demand for retail and office space and allow for same store rental rate increases.   For a more complete discussion of the impact of rising rates on REIT financial performance as well as a more detail on the new pass-through provision, readers should see my earlier article “Consider Equity REITs for Your Next Investment“.

Final Thoughts

Realty Income is a solid investment below $50/share for those with a long term investment horizon.  It is not a stock suitable for trading with its slow and steady earnings growth and low volatility.  However, for those investors looking for a steady growing income stream, it would be difficult to find a better option than Realty Income.

Realty Income sailed through the 2009 financial crisis with only a slight reduction in its dividend growth rate and it should continue to do well in an environment of slowing rising interest rates.  Investors in Realty Income will also benefit from the latest changes to the tax code via the 20% deduction for pass through income applicable to REITs, MLPs, and general partnerships.

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