Realty Income (NYSE: O) is generally considered a rock-solid real estate investment trust (REIT) with a long track record of delivering predictably strong profits and growing dividends. However, like many other REITs with retail and service-based properties in their portfolio, Realty Income hasn't been a top performer this year. As of this writing, its stock price is down by about 18% so far in 2020, compared with a 10% gain in the S&P 500.
Should investors be worried about Realty Income as the COVID-19 pandemic continues, or is it a great opportunity to add a rock-solid REIT at a discount?
Built for steady income and growth
Many investors are scared to invest in any type of retail stock, and given the recent wave of retail bankruptcies and store closures, it's easy to understand why. But Realty Income isn't just another retail REIT.
If you aren't familiar with the company, Realty Income invests primarily in freestanding retail properties and owns more than 6,500 properties in the U.S. and U.K., leased to about 600 tenants. But it's the type of tenants that differentiates it.
Realty Income focuses on three specific types of retail businesses: nondiscretionary (businesses that sell things people need), service-based, and discount-oriented. The idea is that these businesses are not easily disrupted by e-commerce competitors and also are quite recession-resistant. In addition, all Realty Income's properties are on long-term net leases to tenants. In simple terms, this means the tenants commit to leases with initial terms of a decade or more and agree to cover property taxes, insurance, and most maintenance costs. For Realty Income, this means the variable costs of owning its properties are shifted to the tenants.
One look at Realty Income's track record shows why this business model is different from, say, mall or shopping center REITs. Since listing on the New York Stock Exchange more than 25 years ago, Realty Income has delivered 15.3% annualized returns for investors and has increased its dividend for the past 92 quarters in a row. To put this in perspective: Someone who invested $10,000 at the time of Realty Income's NYSE listing would have an investment worth nearly $380,000 today.
Realty Income in the COVID-19 pandemic
Now, for the bad news: Realty Income hasn't exactly been left unscathed by the COVID-19 pandemic. While most of its tenants operate so-called essential businesses and have been open throughout 2020, that isn't the case for the entire portfolio. For example, fitness center operator LA Fitness and movie theater operator AMC Entertainment (NYSE: AMC) are among Realty Income's 10 largest tenants, and both have been operating on a limited basis (or not at all) for most of the year.
However, the business itself is doing quite well. For the third quarter, Realty Income collected more than 93% of its contracted rent and has executed deferral agreements for much of the rest. Theaters (which represent 5.7% of the company's contracted rent) remain a weak spot, but that's really about it. In short, most of Realty Income's tenants are open for business and paying rent.
Not only that, but Realty Income's profitability hasn't been affected. In fact, through the first nine months of 2020, Realty Income generated $2.55 per share in adjusted funds from operations (FFO) -- that's a 3.7% year-over-year increase.
A rock-solid income machine at a discount
To be sure, Realty Income's business was affected by the COVID-19 pandemic. However, with virtually all of its tenants reopened, a high rent collection rate relative to its peers, and profit growth in 2020, Realty Income may not deserve the 18% discount its shares have received. If you're looking for steady growth and income in your portfolio, Realty Income could be worth a closer look.