Real estate investment trust (REIT) Realty Income (NYSE: O) is a bellwether name in the net lease niche. It has the track record to back up that designation. That said, the coronavirus bear market opened up a huge opportunity for long-term investors to buy into this well-run REIT. But things have changed, and Realty Income is no longer a bargain. Here's what you need to know before buying this reliable dividend payer.
Clearly well run
One of the biggest things investors focus on when they look at Realty Income is its dividend. There's the fact that the REIT pays monthly, which makes the dividend a sort of paycheck replacement. But the really impressive number is 27. That's the number of consecutive years that Realty Income has increased its dividend annually, which puts it in the elite Dividend Aristocrat sphere. You don't build a streak like that by accident.
So, from a dividend investor's perspective, Realty Income clearly appears well-run and, in fact, has deftly handled many economic ups and downs throughout its history. The historical dividend growth rate isn't huge, averaging in the mid-single digits over the past decade. But that's been more than enough to beat the historical growth rate of inflation, meaning that shareholder buying power has grown over time -- another win for investors.
At this point, the REIT is pretty big, with a portfolio of around 6,500 commercial properties. But that hasn't stopped it from finding new ways to support long-term growth. Notably, it recently moved into the United Kingdom, which makes up around 4% of its rent roll. As it learns the ropes "across the pond," this will open up a new region for long-term investment. Realty Income also has modest positions in the industrial (10% of rents) and office (3%) sectors that it can exploit if it chooses to, or needs to, expand beyond its current reliance on retail (85%) properties.
From a business perspective, there really is a lot to like here. But you can't just look at Realty Income's business when you consider buying it; you have to think about what you're paying.
One of the easiest ways to look at valuation is dividend yield, since dividends tend to be fairly stable over time. Right now, Realty Income's yield is around 4.6%. While that's higher than the average REIT's 4.2% yield, using Vanguard Real Estate ETF (NYSEARCA: VNQ) as a proxy, it is actually about middle of the range for the REIT over the past decade and decidedly near the low end of the company's long-term history.
Early in the year, when Realty Income's yield spiked over 6%, there was a solid entry opportunity. But that bear-market yield is long gone at this point. At best, Realty Income's yield suggests a fair to slightly expensive entry point. But don't stop with yield.
Taking a step back and examining the REIT's underlying performance is important, too. In the third quarter, adjusted funds from operations (FFO) was $0.81 per share. Times are fluid today thanks to the coronavirus, but assuming this number is a decent run rate, that means annualized adjusted FFO is $3.24 per share. With Realty Income's stock trading hands at around $62 per share, that puts the price-to-adjusted FFO ratio, which is similar to a P/E for an industrial company, at over 19 times.
Realty Income is a well-run REIT, but 19 times adjusted FFO is the kind of number you'd expect from a growth stock. Realty Income's claim to fame is a slow but steadily increasing dividend. Investors desperate for yield have bid the shares up, and they just aren't as attractive today as they were during the early 2020 bear market.
What to do?
Realty Income is a well-run REIT -- its impressive dividend history attests to that. However, investors are well aware of this fact and have placed a premium price tag on the shares. If you're looking at Realty Income today, you need to understand you're paying up for the privilege of owning it. That may be a tradeoff you're willing to make for a consistent monthly income stream. But go in knowing that this is the tradeoff you're making, or you could end up surprised by what you've paid if investor sentiment shifts in a negative direction again.