Realty Income: A REIT That's Paid Monthly Uninterrupted Dividends Since 1969

Realty Income (O) was founded in 1969 by a husband and wife team. As one of the first REITs, Realty Income started with a single investment in a Taco Bell and now owns more than 6,400 properties across America that are leased to about 300 commercial tenants in 50 different industries.

Retail properties generate 83% of the REIT's rental revenue. The firm also owns industrial warehouses (11%), offices (4%), and farmland (2%). 

All of Realty Income's properties are under long-term triple-net lease agreements, which provide solid cash flow visibility and shift property operating expenses such as maintenance, utilities, insurance, and taxes to the tenant.

Realty Income has paid uninterrupted monthly dividends since its founding in 1969 and increased its dividend each year since going public in 1994, making it a dividend aristocrat.

Business Analysis
Few companies have maintained as strong of a dividend growth track record as Realty Income. The REIT's success is driven by its disciplined capital allocation strategy, financial conservatism, and diversified property portfolio. These factors have combined to create an extremely resilient business.

Realty Income’s long-term growth has been nothing short of outstanding. Since 1994, the company has grown its real estate assets (at cost) from $451 million to nearly $20 billion; expanded the number of industries served by its portfolio from 5 to 50; increased its number of commercial tenants from 23 to 301; and boosted its annual revenue from $49 million to $1.5 billion. 

However, Realty Income has always taken a disciplined approach to growth. For example, at the time of its founding over 50 years ago, the firm believed that buildings should be financed without the use of debt.

In the early days, Realty Income relied on raising small amounts of equity capital from investors to fund its property acquisitions, taking a conservative approach to growth that helped it navigate through the commercial real estate market's boom and bust cycle in the 1980s.

Today, Realty Income continues to rely primarily on a mix of equity and unsecured debt financing rather than using mortgages. Management also targets a conservative capital structure, helping Realty Income maintain an A- credit rating from Standard & Poor's and access low-cost funding for its property acquisitions.

Relatively cheap financing helps ensure that the company can earn favorable investment spreads, which represent the difference between the cost of capital Realty Income uses to buy a property and the property's lease yield (rental payments relative to the price paid for the property).

Realty Income's discipline extends to its real estate acquisition strategy as well. The REIT will only purchase freestanding, single-tenant properties located in big markets and/or key locations that it can lease to tenants with superior credit ratings and cash flows.

In fact, tenants with investment-grade ratings account for 49% of the firm's total revenue, and its average tenant rental coverage ratio (operating cash flow / rent) is 2.8x, which is very healthy for this industry.

The retail business is very much driven by location, and Realty Income’s portfolio clearly plays to this critical success factor; the company’s occupancy rate has never dipped below 96%, even during the financial crisis.

Sustained high occupancy rates signal the premium locations of Realty Income’s properties and the financial strength of its tenants. High occupancy rates are also indicative of the switching costs faced by many retailers, who don’t want to risk disrupting their established customer base by moving to a new location to save a bit on rent.

Equally important, Realty Income is not betting on any one client or industry for its future success. After all, a high occupancy rate is of little value if a single tenant accounts for a major portion of rent (e.g. 15%+ of total rent) and goes under or decides to walk away after its leases expire.

Realty Income’s largest tenants by rent are Walgreens (6.1%), 7-Eleven (4.8%), Dollar General (4.4%), FedEx (4.0%), and Dollar Tree (3.5%). Its three largest industries by rent are convenience stores (11.6%), drug stores (8.6%), and dollar stores (7.3%), and no state accounts for more than 11% of total rent.
Source: Realty Income Investor Presentation
Importantly, Realty Income focuses on leasing to tenants that have a service, non-discretionary, and/or low price point element to their business. Over 95% of the company’s total portfolio rent is from tenants that possess at least one of these components or only have non-retail operations.

In other words, these tenants are seemingly better positioned to survive a variety of economic conditions and more effectively compete with the continued rise of internet retailers.

However, management's assertion that nearly all of its total portfolio rent is insulated from retail's cyclical and secular challenges seems a little aggressive. For example, movie theaters account for 6.7% of rent and face long-term pressure from video streaming. It's also hard to argue they have a "low price point."

Regardless, in today's evolving retail world, it is comforting to see Realty Income's healthy level of industry diversification and the relatively high rent contribution it receives from industries that appear to have staying power such as convenience stores, dollar stores, and grocers.
Source: Realty Income Investor Presentation
Overall, it’s hard not to like Realty Income’s business. The company owns thousands of retail locations that continue holding their ground in the digital age. Management runs the business with a conservative capital structure. And the property portfolio is well diversified by tenant, industry, and geography while enjoying solid cash flow visibility thanks to its long-term net leases.

Looking ahead, Realty Income should have plenty of opportunities to continue expanding its portfolio as well. The total size of the single-tenant retail property market is estimated to be approximately $1 trillion, according to National Retail Properties. Realty Income’s revenue sits near $1.5 billion, leaving plenty of room for future expansion.

Key Risks
It’s challenging to identify many risks that could impair the long-term earnings potential of Realty Income.

The company’s diversification, financial conservatism, and focus on quality tenants and defensive, Amazon-resistant industries eliminate many fundamental risks faced by other retail REITs. 

However, Realty Income is obviously still very exposed to the consumer retail sector (83% of total rent), which is constantly evolving due to changing consumer preferences and the continued rise of e-commerce.

While it has done a great job of shifting its tenant base to relatively e-commerce resistant tenants over the years, there is always the risk that omnichannel could eventually reduce the importance of certain physical locations. For example, perhaps in the future some companies will merely use their physical store locations as delivery and return points for increasingly online driven sales.

Fortunately, Realty Income is not overly exposed to any single industry. For now, it seems unlikely that the continued rise of e-commerce would materially impact demand across many of Realty Income’s tenants, much less jeopardize their ability to continue making rent payments.

Another risk to consider is how long the REIT can maintain its historical 4% to 5% annual growth rate. While the U.S. real estate market is large and fragmented, allowing for plenty of new acquisition opportunities, Realty Income's increasing focus on top quality properties and tenants with stronger credit ratings could limit management's ability to scale up acquisitions to maintain its growth rate. 

Overall, Realty Income appears to have low fundamental risk. 

Closing Thoughts on Realty Income
Realty Income’s predictable cash flow, strong balance sheet, disciplined approach to acquiring properties, portfolio diversification, and access to low-cost capital make its dividend among the safest of any REIT’s. These factors also help ensure that management can keep growing the business (and the payout) for the foreseeable future – regardless of where interest rates or the economy turn.

Simply put, Realty Income is arguably the most reliable monthly dividend stock in the market for conservative investors seeking a blend of current income and moderate but dependable payout growth. 

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