Real estate investment trust (REIT) Realty Income (NYSE: O) is a bellwether name in the net lease sector. It has earned that distinction, too, paying reliable and growing dividends for more than 25 consecutive years. Only that's the past, and investors always need to be thinking about the future. Here's a quick look at some things to think about over the next three (and more) years at Realty Income.
1. Even bigger
There is one very simple answer to the question of where Realty Income will be in three years' time: bigger. The REIT focuses on single-tenant net lease assets. That means that it owns the property, but its lessees have to pay for most of the operating costs of the properties they occupy. This is generally considered a low-risk approach in the REIT space, but it is really something of a carry trade.
Effectively, Realty Income makes the difference between the rents it charges and its cost of capital. In order to keep growing, it needs to keep adding buildings to its portfolio. So, the main goal here is to continue expanding the portfolio over time, and that's exactly what investors should expect.
The problem with getting bigger is that it gets harder and harder to grow as a company gains scale. To oversimplify things, a REIT with just one building would double its portfolio if acquired a second property. A REIT with 100 properties would only increase its portfolio by 1% with the addition of a single building. Realty Income currently owns a portfolio of around 6,600 properties.
So while Realty Income is likely to be bigger in three years, don't expect that to translate into massive growth. Slow and steady is the likely path because it requires either more deals or larger deals to impact the top and bottom lines here.
3. More foreign
With such a large portfolio already, Realty Income's opportunity set is important to consider. To scoop up all of the properties it needs, it can either take on lesser assets or start spreading into new areas. Management has, quite logically, chosen the latter. This is why a few years ago Realty Income started to invest in the United Kingdom. The UK now accounts for around 6% of the REIT's rent roll.
However, long-term investors should probably view this as a gateway investment. Basically, Realty Income is trying to learn the ropes in a new region so it can expand its opportunity set. It wouldn't be surprising to see the REIT start buying more foreign assets and, perhaps, in other European countries over the next few years.
4. Beyond retail
Realty Income's bread and butter is retail assets, with around 84% of its rents coming from the sector. The rest is from a mix of industrial, office, and vineyard properties. While the wine-related investment was opportunistic and unlikely to be repeated, industrial and office space could offer Realty Income opportunities for expansion beyond its retail core. Although the next three years aren't likely to see huge changes in the company's sector allocations, this is something to watch. Effectively, Realty Income's size will likely require it to eventually consider much more than just retail opportunities.
5. A different kind of acquisition
That said, Realty Income could also look at buying entire portfolios rather than just doing one-off deals on its own. This is something it has done historically and it wouldn't be shocking to see happen again. The problem here is that buying a portfolio means you take the good with the bad and, notably, you don't get to set the lease terms. Thus, portfolio acquisitions are a quick but dirty route to growth. Although Realty Income has always actively managed its portfolio, which includes selling assets, if it does dip into the mergers and acquisitions space, expect property sales to become more prominent as it looks to clean up its core portfolio.
Maybe not so simple
Looking out three years at Realty Income, there is a very simple way to view the future: Management will keep doing what it has done so successfully for years and grow the portfolio. However, when you dig into the story a little, "bigger" isn't as simple as it seems. Realty Income's size makes growing increasingly more difficult, which means it will have to consider more and more avenues for growth. And that is what makes the way Realty Income chooses to grow over the next three years the key thing to monitor.