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Realty Income Earnings: Abundant Opportunity Produces Strong Growth

By Matthew Frankel, CFP® – Oct 26, 2016 at 2:16PM

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Realty Income is buying properties at a rapid pace -- here's what you need to know.

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Leading net-lease retail REIT Realty Income (O -0.54%) reported third-quarter earnings that included impressive year-over-year growth as well as a higher-than-expected volume of acquisitions. Although the results were slightly lower than analysts had expected, the company increased its guidance for the year and has an optimistic outlook for the future.

Realty Income's third quarter

For the third quarter of 2016, Realty Income reported adjusted funds from operations (AFFO) of $0.72 per share, a 2.9% increase over the same quarter a year ago. This is considered the most accurate metric of REIT earnings, as it adjusts for real estate-specific factors such as depreciation and also excludes one-time and other special items.

Analysts had expected $0.73, so this is a slight miss. However, the good news is that the company narrowed its full-year guidance from a range of $2.85-$2.90 to $2.87-$2.89, which is considered a guidance raise, since it boosts the midpoint of the range by a half-cent.

The big "surprise"

Realty Income generally doesn't surprise investors in its earnings reports, and that's a good thing. However, one pleasant surprise in the third quarter's report is that Realty Income continues to acquire properties at a significantly higher volume than expected. The company added 93 properties to its portfolio during the third quarter at a cost of $410.2 million, which brings the total acquisition volume for the year to approximately $1.1 billion. To put this in perspective, Realty Income's original full-year 2016 estimate was for $750 million in acquisitions.

The market for attractive properties to acquire has been so robust that Realty Income has increased its full-year estimate in every single quarter since that initial projection. Now, the company sees a full-year acquisition volume of $1.5 billion -- double the original projection. It makes sense: With the persistent low-interest-rate environment, Realty Income's cost of capital is extremely low, which creates the opportunity for attractive investment spreads. Investors should be encouraged that Realty Income is aggressively taking advantage of it.

CEO John Case said the acquisitions were completed "at attractive investment spreads to our cost of capital" and that "we continue to see an active pipeline of investment opportunities." With comments like that, I wouldn't be surprised to see another ambitious goal for 2017, especially if rates stay low.

No negative surprises, again

As I mentioned, Realty Income generally doesn't surprise its investors, at least not in a negative way. In fact, the main appeal of Realty Income's stock is its ability to generate market-beating returns and growing dividends without any drama.

You can read more about why Realty Income's business is so rock-solid here, but to sum it up in a couple of sentences, let's just say that Realty Income invests in retail businesses with little threat from online competitors or recessions. And the tenants are on predictable net leases with 10- to 20-year initial terms.

It is this predictability that has allowed Realty Income to build up one of the most impressive dividend track records in the market. The company recently declared its 556th consecutive monthly dividend payment, and it has increased the payout at an annualized rate of 4.6% in good economic times and bad.

Cheap access to capital means lots of room to grow

Finally, one of the major perks of Realty Income's rock-solid business is that the company can get money cheaply so it can grow. REITs finance acquisitions in two ways -- by issuing equity or by borrowing money. On the equity side, when Realty Income's stock price is valued highly, the company doesn't have to issue as many new shares to raise money. For example, if Realty Income wants to raise, say, $1 billion, a share price of $60 means it can do so with 18% fewer shares than if the stock was at $50.

As far as debt goes, Realty Income's latest bond offering was yet another good news item on the earnings report. In October, Realty Income issued $600 million of 10-year bonds at a yield of just 3.15%, the company's lowest yield on a 10-year bond in its history.

With this cheap access to capital and Realty Income's credit, the company has virtually unlimited access to low-cost financing to pursue as many attractive opportunities as it can get its hands on, and that's what will allow the company to keep producing market-beating returns.

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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