Realty Income: Buy, Sell, or Hold?

It’s been a tough past several months for real estate investment trusts (REITs), and Realty Income (NYSE: O) has been no exception. Its shares are down 25% from their mid-2022 peak thanks to a combination of higher interest rates and economic lethargy. This weakness has been rekindled just since the beginning of the year.

Is this pullback a buying opportunity, now that the dividend yield’s a healthy 5.6%? Or is the recent weakness a warning of what’s to come? Perhaps it’s something in between.

A different kind of REIT

A real estate investment trust — or REIT, for short — is an organization that holds rent-bearing or revenue-producing properties like apartment buildings, shopping malls, or hotels. REIT stocks like Realty Income are bought and sold like any other kind of stock.

But their structure offers shareholders one advantage that stocks of more conventional companies don’t. That is, as long as the bulk of a REIT’s profits are passed along to shareholders, none of its income is taxed at the corporate level first. The end result is more earnings to share with the REIT’s owners.

Even by REIT standards, however, Realty Income is unusual for a couple of reasons. First is its focus. The company specializes in retail and consumer-facing properties. Walgreens, Dollar General, and Dollar Tree are its top three tenants, although no single renter accounts for more than 4% of its revenue.

Its tenants are also spread out across several different slivers of the retail industry. All told, it owns more than 13,000 different properties (mostly in the United States). This diversification and the company’s sheer size act as a buffer against economic turbulence.

And the other unique characteristic of Realty Income? Unlike most other stocks and REITs, this one pays its dividends on a monthly, rather than a quarterly, basis. It’s done so with incredible reliability too. Indeed, this REIT has not only paid 643 consecutive monthly dividends, but has raised its payout 123 times since its formation in 1994.

Better yet — and unlike some other companies — Realty Income’s operating earnings are still more than fully funding its dividend payments. Credit the fact that the real estate investment trust’s occupancy rate consistently holds above 98%. This actually makes sense, however. Its tenants tend to be retailers that plan on sticking around once they go to the expense of setting up a new store or site.

The market is more worried than merited

It all sounds great, so what went wrong in the middle of 2022?

You may recall that that’s when the Federal Reserve started pushing interest rates higher, in an effort to curb then-burgeoning inflation. While higher interest rates don’t pose a catastrophic threat to Realty Income’s business, they can be a headwind. Not only will higher rates increase a REIT’s own borrowing costs, they can crimp retailers’ demand for new retail space.

The retail industry is also already feeling plenty of pressure. Numbers from Coresight Research indicate that more than 4,600 storefronts were shuttered in the U.S. alone last year, reflecting the growing competition of online shopping alternatives, as well as waning demand prompted by continued growth in prices.

Investors’ worry over this REIT’s struggle, though, may be overblown.

Take the ongoing growth of its portfolio as an example. As of the end of September 2023, Realty Income owned a little over 262 million square feet worth of real estate spread out across 13,282 different properties. That’s up from 11,733 properties and a little less than 226 million square feet at the same point in time in 2022. Yet, Realty Income is no less profitable now than it was then. Clearly, it’s finding a way to handle higher financing costs and still continue growing.

Underscoring its strength as a landlord is the growth of its rental rates despite economic uncertainty. Same-store rental revenue of $716 million for the three-month stretch ending September is up from the year-earlier comparison of $701 million, suggesting that the REIT’s still got plenty of pricing power. Moreover, Realty Income recently upped its full-year 2023 rent growth expectations, again pointing to healthy (if selective) demand for retail space.

There’s the reason Realty Income is a ticker income-minded investors should view as a buy while it’s down and the dividend yield is up. This recent weakness seems to be rooted in far more worry than is merited.

Realty Income is a buy for income-seeking investors

Never say never, of course. It’s possible interest rates could continue creeping higher, chipping away at Realty Income’s bottom line. It’s also possible that demand for retail space could crumble as the world increasingly does more of its shopping online, or worse, stops shopping altogether.

These worst-case scenarios are looking decreasingly likely, though. Traders are still betting that the Fed is going to cut interest rates at least three more times this year, if not four — in keeping with the Fed’s own view. At the same time, the fourth quarter’s initial GDP growth reading was a healthy 3.3%, versus expectations of only 2% growth.

The U.S.’s economy is faring better than many seem to think it is, and it’s doing better without putting a great deal more upward pressure in inflation. That’s an ideal backdrop for all REITs, but particularly REITs like Realty Income that depend so heavily on consumer-facing tenants.

Bottom line? If you’re on the hunt for reliable dividends from a stock with more upside than downside ahead, Realty Income is certainly one to consider.

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James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Realty Income. The Motley Fool has a disclosure policy.

Realty Income: Buy, Sell, or Hold? was originally published by The Motley Fool