Real estate investment trusts (REIT) have been on a big run in 2021 after a particularly rough year in 2020. But through both the ups and downs, Realty Income (NYSE: O) always seems to trade a bit on the expensive side. There are very good reasons for this trend and why, for conservative investors, it might be well worth the expense.
1. What a record
Realty Income has increased its dividend annually for over 25 consecutive years, making it a Dividend Aristocrat. That's hardly the longest streak in the REIT space, which likely goes to Federal Realty and its over-five-decade-long streak (Dividend King territory). But Realty Income has another dividend streak that sets it apart. This REIT has increased its dividend every single quarter for 95 consecutive quarters. That's a level of consistency that is incredibly impressive.
2. Replacing the paycheck
In addition to getting quarterly bumps, Realty Income also pays its dividend monthly. That makes shifting from a paycheck to living off of your savings a lot easier to schedule, something that many investors appreciate. Since REITs are specifically designed to pass income on to shareholders, points one and two are very big positives. However, alone, they don't fully explain the high price tag usually afforded to Realty Income.
3. The 800-lb. gorilla
So a great dividend sets the stage here and shows that the company is well run. However, it also happens to be an industry giant owning roughly 6,600 properties. It is the biggest name in the net lease sector by market cap. And it's about to get even bigger, expanding its portfolio to around 10,000 properties via the acquisition of peer VEREIT. Following the merger, Realty Income expects to be over twice the size of its next-closest competitor. That will give it a scale advantage that will set it far apart from the pack, helping to keep operating costs low and financing costs modest and allowing it to take on big deals others couldn't manage. It already had these advantages, but they are set to become even bigger advantages.
4. The net lease thing
The term net lease is important, because it is viewed as a relatively safe way to invest in real estate. Essentially, in this arrangement, the tenant is responsible for most of the operating costs of the property it occupies. It's simplifying things a bit, but Realty Income just has to collect rents. The key here, however, is that this REIT is a giant with a great track record in what is seen as a relatively safe niche of the real estate industry. Is it any wonder that investors are fond of the stock? Only the story doesn't end there.
5. Investment grade
In addition to using a conservative investment approach, Realty Income also has a conservatively financed balance sheet. That's worth considering in more detail. Rated A- by S&P, it can issue debt at impressively low rates. To put a number on that, in late 2020 it issued two bonds totaling $750 million that had a combined interest rate of just 1.478%. Soon-to-be-acquired peer VEREIT's interest expenses are notably higher than that. This is interesting because, after the merger closes, Realty Income will be able to refinance VEREIT's debt at lower rates, making the deal even better for investors. That said, cheap access to capital is important for REITs, and with or without VEREIT, Realty Income stands out.
But this isn't the only place where the term investment grade plays a role. Realty Income also gets about half of its rents from investment-grade tenants. Investors tend to like that, since it suggests rents will get paid in both good markets and bad. While this number will drop to around 45% after the VEREIT merger, it will still be high enough to please even more conservative types. So, Realty Income is well run, consistent, and fiscally conservative.
Not everything is good, but that's OK
So there are a lot of reasons to like Realty Income and that's why the stock has a history of trading at a premium price. That said, there are negatives, like the fact that being so large means growth is modest (which means dividend growth is modest, too). However, for conservative investors who want to make sure the dividend checks keep coming, Realty Income is probably worth paying up for. But be careful not to pay too much.
The REIT's 4.2% dividend yield today is sort of in the lower side of the trend over the past decade, so it isn't a screaming buy. It's probably fairly priced to a little expensive. That might be fine for some investors, though those with a value bias will likely be better off waiting for a pullback. A yield in the 5.5% and higher area would probably represent a very attractive energy point. That said, the shares don't get that cheap very often, so you'll want to keep Realty Income on your wishlist and watch it very closely.