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Realty Income: The Monthly Dividend Company

Opdateret: 10. jan.

Realty Income Corporation (ticker: O) is a real estate investment trust (REIT) that focuses on providing dependable and growing monthly dividends to shareholders. The company primarily invests in commercial properties, with a diversified portfolio that includes retail, industrial, and office spaces across various sectors. Realty Income is known for its unique business model, often referred to as the "Monthly Dividend Company," and has a history of consistent dividend payments, making it an attractive choice for income-seeking investors.

This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money.

This post is written by Caio Daud. A popular investor on eToro. Learn more about Caio here:

Caio is proud to say he is a Dividend Growth Investor. He is the founder of the Income Growth Office and is passionate about dividends. When he is not reading a book about investing, he is annoying his family and friends with new investment ideas or bragging about a company that has just increased their dividends.

The Income Growth Office is a community managed by seasoned investors. We differentiate ourselves as a community aligned by a profound belief in the potential of Dividend Growth Investing. Follow us on Instagram (The Income Growth Office (@incomegrowthoffice) • Instagram photos and videos) to have access to our FREE Newsletter: My Second Salary. You can check live or copy our Dividend Growth Portfolio, on eToro (@CaioDaud).

If you want want to purchase shares or fractional shares in Realty Income, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start your investment journey with as little as $50.

Overall, REITs offer a way for investors to diversify their portfolios with real estate assets and to receive a share of the rental income and profits from those assets without having to own and manage the properties themselves.

I think this type of business, like utilities, is very perennial: hardly the sector will face disruptions on its working mechanisms. People and businesses need land to live and operate, doesn’t matter in which phase of economical cycle we are living under. Rents will have to be paid, monthly most times. What other sector offers such a secure and steady flow of monthly income?

REITs give us the opportunity of owning part of a property rent just with a click of a button in our broker. Again, we don’t have to deal with property maintenance, rental negotiation, or tenant management.

Now, why Realty Income (O) and not another REIT?

Realty Income (O) has an excellent tracking record of delivering income to its shareholder. It started 1969 with a single investment in a Taco Bell and, today, it owns thousands of properties across America that are leased to hundreds of tenants operating in dozens of industries.

O has paid a dividend since its first year going public, in 1994, and has increased it every single year since then, making itself a dividend aristocrat.

Such achievement is conquered by a very predictable cash flow structure: due to its triple-net lease agreements, O shifts property operating expenses such as maintenance, utilities, taxes… to tenants, freeing itself from unplanned costs.

All this steady cash flow* generated by the thousands of properties owned by Realty Income has to be almost fully distributed to shareholders: REITs are required to distribute at least 90% of their taxable income to shareholders in the form of dividends.

*Due to the constant presence of the above-mentioned unexpected expenses, it is common sense to not use free cash flow when evaluating a REIT’s capital generation capacity, instead, we use a metric called Adjusted Funds from Operations (AFFO).

This has one important and big impact on how REITs operate their businesses: in order to grow, they need to borrow money.

Money is borrowed mainly in two ways:

Equity Issuance: REITs can raise capital by issuing shares to investors. This is why, it’s common to see the an increasing number of shares outstanding overtime for REITs.

Debt Financing: REITs can borrow money by issuing bonds or taking out loans. This debt is secured by the REIT's real estate assets.

Both money raising structures have their advantages and flaws and one of the most important tasks of REITs’ top management is finding the best compromise between raising debt and issuing new shares.

A second crucial aspect of how REITs operate involves their reliance on acquisitions for growth. Unlike traditional companies that can expand by selling products or services to new customers, REITs generate revenue by leasing their properties. Since the number of properties is finite and REITs are required to distribute 90% of their taxable income, expanding their businesses necessitates the acquisition of new properties. (Raising rents is not enough to sponsor AFFO growth).

For large entities like Realty Income (O), which manages thousands of real estate assets, the impact of acquiring a few properties would be negligible in terms of AFFO growth. Given its scale, Realty Income must engage in acquiring other real estate businesses to achieve meaningful growth in terms of AFFO.

We will see how the above characteristics explain Realty Income’s stock performance last year (down 10%):

The first two aspects that backs O’s rally is due to high and increasing interest rates in 2023:

[a]. As mentioned earlier, REITs have a business model that is high-dependent on debt to finance growth. Debt can become tricky to manage with the constant increase of interest rates.

[b]. Just like Utilities, REITs compete with bonds and high yield savings account when investors are deciding where to put their money. During periods of high rates and inflation, bonds and savings accounts become very attractive to investors, causing investors to close their positions on REITs.

The last aspect that explains Realty Income underperformance last year, was some doubts the market put on the last acquisitions performed by the REIT.

Talking about the last endeavor: O acquired Spirit Realty Capital (SRC) on a $9.3 billion operation, which represented a 15% premium on Spirit’s share price.

The doubt possibly arose on SRC’s slightly worse debt profile and a less exposure to high quality tenants.

The images below show how well, in my opinion, SRC’s acquisition is complementary to O’s portfolio of tenants and how dispersed the portfolio will remain. Yet, note the quality of its biggest tenants:

Tenants’ quality and rate of occupancy are other important metrics when evaluating a REIT. 40% of Realty Income’s rent comes from investment-grade tenants. Yet, O presents a rate of occupancy of 99%, once again, showing the ability of its top management to secure profitable and long-lasting contracts.

The above characteristics summed with their non-concentrated portfolio makes Realty Income very resilient to tenants’ default and extraordinary circumstances like the COVID-2020 pandemic.

With the last updates from Powell hinting the first possible interest rate cuts for 2024 and the market finally starting to see value in SRC’s acquisition, Realty Income has beaten the SP500 in the last two months (Nov and Dec 23):

I remain very bullish on O for 2024. I think REITs, together with a few other sectors, will rise considerably with the first cuts in interest rates. (Not an investment advice).

The company’s debt profile is very strong with only 8% on variable rates and only 15% of its fixed rate maturing in the next 3 years. When O will need refinancing and new debt for its acquisitions, we will be probably facing an environment of lower interest rates. Moreover, Realty Income has a “A-“ Credit Rating from Standard & Poors, lowering even more its cost to access capital.

Such financial perspective keeps O poised to increase its 28 years of dividend growth streak:

Realty Income, like most REITs, is a slow dividend grower (3% yearly in the last 5 years). On the other hand, its bad performance last year is presenting us with a not common and very high dividend yield:

The last-5-year average is 4,4%. Right now, O is 21% discounted according to the Dividend Yield Theory.

The (almost) 7% yield opportunity presented in the end of last year may have passed, but under this model, Realty Income remains discounted.

Under a P/E perspective (actually P/AFFO), O is striking a 22% discount in relation to itself:

My personal Target Price for O is $47,75 and I was able to add to my position in the dip presented last year.

In conclusion, I believe Realty Income’s top management has a very good tracking record of very thoughtful acquisitions and debt/equity coordination. The company is scoring a very solid financial position, presenting a high-quality portfolio of tenants and 99% of property occupation. In my opinion, all this high-quality characteristics summed with its excellent tracking record of dividend and AFFO increases grants O the status of the safest dividend grower among all REITs

To end, the bright perspective for interest rate cuts will attract investors back to investment routes like REITs, increasing demand for their share and, consequently, their share prices. I believe O is well positioned to be the REIT leader in this potential new wave of capital infusion.

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