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3 Reasons Realty Income's Stock Could Rise

By Matthew Frankel, CFP® – Aug 11, 2016 at 12:24PM

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This retail REIT giant has performed well in 2016, but there could still be room to the upside.

Image source: Getty Images.

Realty Income (O 2.99%), like many other REITs, has performed exceptionally well this year, with shares up about 33% year to date, and that's after a recent pullback. Despite the big rise in price, there are some reasons to believe there is still some upside from here. With that in mind, here are three things that could catapult the retail real estate giant's stock to the next level.

O Chart

Interest rates could stay low

Low interest rates help REITs, and high-quality ones like Realty Income in particular, for a couple of important reasons.

First, although Realty Income doesn't like to carry high debt levels, it does use a significant amount of borrowed money to acquire properties. Lower interest rates translate to lower borrowing costs, which typically means better profit margins for REITs. This could especially be a factor if Realty Income's second-half acquisition volume picks up, as the company has said there is an abundance of attractive opportunities in the market right now.

Next, low interest rates make REITs more attractive to income-seeking investors. In a world where 10-year Treasury bonds pay just 1.5% and investment-grade corporate bonds don't pay much more, REIT dividends of 3% or more can seem extremely attractive. Sure, Realty Income is on the lower end of the dividend spectrum as far as REITs go, but this is made up for by the company's dividend history and overall financial strength.

10 Year Treasury Rate Chart

Comparison of Vanguard REIT Index ETF (NYSE: VNQ) dividend yield with 10-Year Treasuries and AAA-rated U.S. corporate bonds.

The persistent low-interest-rate environment has lasted longer than most experts had expected, which is a big reason for the exceptional performance of REITs this year. If the Federal Reserve decides to hike rates even lower than the market currently expects, it could be the catalyst for the next leg up.

Acquisition volume could be greater than expected

During the first half of the year, Realty Income completed $663 million in acquisitions at record high spreads relative to the cost of capital. In fact, Realty Income is so optimistic about the current investment opportunities in the market that it increased its projections for the full year. As CEO John Case said in the second-quarter earnings release: "We continue to see an ample pipeline of investment opportunities. As a result, we are raising our 2016 acquisitions guidance to approximately $1.25 billion from our prior estimate of $900 million."

In other words, the investment opportunities have been so compelling this year that the company is planning to acquire nearly 40% more new properties than it planned. If the cost of capital stays low -- since Realty Income finances most of its deals through equity, so this means if the stock price stays high -- there's no reason the company can't acquire even more, or that this trend can't continue into 2017.

In a nutshell, larger volumes of acquisitions at high spreads can result in more rental income for shareholders.

Profits (and dividends) keep rising

Increasing profit is the most obvious reason the stock could rise, but it's certainly worth mentioning. Realty Income has increased its dividend for 76 consecutive quarters, and the company has a history of giving pretty generous increases when financial conditions warrant a higher payout. For example, the recent 1% increase in the dividend represents a 6.1% year-over-year increase for shareholders, well above the company's long-term 4.6% average.

Since higher-than-average dividends are one of the most attractive aspects of REIT investing, dividend increases that are at a greater pace than the market expects could easily serve as a positive catalyst to boost the stock.

Image source: Realty Income investor presentation, Q2 2016.

Is Realty Income a buy right now?

Obviously, after a 33% gain, Realty Income isn't as great of a buy as it was at the beginning of 2016. Having said that, there is a reason for the outperformance, and there are also several reasons the stock could go even higher.

Regardless of whether the three things here happen and lift the stock price in the short term, Realty Income is a rock-solid dividend powerhouse that has consistently generated incredible returns for its shareholders. In fact, a $10,000 investment in Realty Income's 1994 IPO would be worth about $396,000 today. This stock is a high-growth and low-risk investment that deserves consideration for any long-term investment strategy.

Matthew Frankel owns shares of Realty Income. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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