Realty Income (O 0.70%) has increased its monthly dividend for twenty consecutive years, and has established itself as one of the top performing and most consistent real estate investment trusts (REITs) you can buy today. But no company is bullet proof.
Though I can't predict the future, here are three reasons Realty Income's stock price could fall in 2015.
1. So long free money
Following the financial crisis in 2008, the U.S. Federal Reserve dropped short-term interest rates to near zero and started buying massive amount of bonds in an attempt to encourage economic growth.
Unemployment is currently at 5.7% -- well below its high-point of 10% in 2009 -- the housing market has picked up, the stock market has soared, and consumer confidence is up. All told, the U.S. economy is in a much better position than it was six years ago.
The low interest rate environment has also been a godsend for Realty Income. The company borrows to make investments in commercial real estate, and low rates have increased the availability of funding as well as lowered the cost to borrow. This improved returns and made acquisitions more attractive. In fact, Realty Income has nearly tripled in size since 2011.
But that could all begin to change later this year. Fed chairman Janet Yellen said in a speech last December that some of the Fed committee members see a rate hike as soon as the middle of this year. This would increase the company's funding costs, tighten margins -- the difference between borrowing costs and asset returns -- and make acquisitions less attractive.
During Realty Income's most recent conference call, management suggested that yearly rent increases will likely average just 1.5%. As a result, the company will depend heavily on acquisitions to power growth. If acquisitions do fall below the company's low-end guidance of $700 million for 2015, whether it is due to interest rates or not, their stock price is likely to fall.
2. The curse of the high yield
Higher borrowing costs are not the only reason rising interest rates could lower Realty Income's stock price. Because U.S. Treasury bonds offer a risk-free return, and Realty Income does not, Realty Income's dividend yield will almost always float above the 10-year Treasury rate.
As you can see, the rate on 10-year Treasuries has fallen more than one and a half percentage points since 2010. This has encouraged investors to start reaching for yield. And because they carry less risk than many other types of investments, higher yielding REITs like Realty Income were a natural alternative.
Stock prices and dividend yields have an inverse relationship, so as REITs have been bid up over the last few year, their stock prices have soared and their yield has fallen. If this reverses, and treasury rates rise, we will likely see Realty Income's dividend yield creep up and its stock price fall.
3. Family Dollar Merger
On January 22nd, Family Dollar announced that its shareholders had approved its proposed merger with Dollar Tree. Family Dollar is currently Realty Income's fifth largest tenant, and accounts for 4.5% of rental revenue.
The deal itself has little impact on Realty Income, but Family Dollar suggested that the company may have to close as many as 300 locations in order to avoid antitrust violations, which ensure fair competition.
During Realty Income's fourth quarter conference call, CEO John Case suggested that the long-term leases and the strong performance of the properties makes it unlikely that Realty Income's properties are targeted. However, if Realty Income gets unlucky and more than a few of its 454 Family Dollar locations close, it could have a small but still significant impact on earnings, which would negatively impact stock price.
