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Here's Why the Best Is Yet to Come for Realty Income

By Matthew Frankel, CFP® – Jun 2, 2017 at 1:44PM

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Despite the difficulties many retailers are facing, here's why now could be a great time to get in on this retail REIT.

Retail real estate investment trust Realty Income (O -0.40%) has a fantastic track record of delivering income and growth to investors. The company has paid 562 consecutive monthly dividends, and has increased its payout at an annualized 4.7% rate since its 1994 NYSE listing. Even more impressive, the company's total return has averaged nearly 17% per year -- a remarkable level of performance to sustain for more than two decades.

With that record, and with the trouble in the retail sector, it may seem like the best is in the past for Realty Income. However, I'm not so sure.

The numbers "2016" and "2017" with an up arrow above them on an empty road leading to a shining sun

Image source: Getty Images.

What does Realty Income do?

Realty Income is a real estate investment trust, or REIT, that specializes in freestanding, single-tenant retail properties. As of the latest available information, Realty Income owns 4,980 properties located throughout the United States.

The company's properties are spread out across 49 states and Puerto Rico (none in Hawaii), and are occupied by tenants operating in 47 distinct industries. No single industry accounts for more than 11% of the company's revenue, so if, for example, movie theaters fell on hard times, the potential negative effects would be limited to a small portion of Realty Income's properties.

Realty Income's tenant industry breakdown.

Image source: Realty Income investor presentation.

Retail makes up the bulk of Realty Income's property portfolio, but about 20% is made up of industrial, office, and agricultural properties, adding another layer of diversification.

But wait! Isn't retail in trouble?

It's certainly understandable why many investors have a negative outlook on the retail industry, but the truth is that it depends what kind of retail you're talking about. When you consider the major retailers that have either gone bankrupt or are closing stores, virtually all can be put into the same categories.

Specifically, if a retailer only sells discretionary items (things that people don't really need) and/or sells things that are easily obtainable online at a better price, there's a good chance that they're struggling right now.

On the other hand, Realty Income's retail properties are occupied by tenants that don't fit these criteria. Many of its properties sell things that people need, such as major tenants Walgreens and Circle K. These businesses tend to do fine no matter what the economy is doing -- after all, people still need to fill their prescriptions and put gas in their cars in bad economies.

Other properties are occupied by service-based retailers, that is, businesses that primarily sell an experience, not a product. LA Fitness and AMC Theatres are two excellent examples among Realty Income's top 10 tenants. While these businesses are somewhat vulnerable to recessions, there is little threat from e-commerce, so they're likely to do just fine in the long run.

Finally, some of Realty Income's properties are occupied by discount-oriented retailers. Stores like Dollar General, Walmart, and BJ's Wholesale Club often offer unique bargains that even the biggest online retailers can't replicate.

The bottom line is that there are indeed parts of the retail industry that are struggling right now. However, Realty Income doesn't have much, if any, exposure to them.

In addition, Realty Income's tenants are on long-term net leases, which typically have initial terms of 15 years or more and require the tenants to cover the variable expenses of property ownership. This minimizes vacancy risk and income uncertainty.

Still growing strong

Over the past few years, Realty Income has done an excellent job of taking advantage of the low cost of capital and has grown rapidly. In fact, since 2012, Realty Income's portfolio has grown in size by about 65%. In 2016 alone, Realty Income spent $1.86 billion on acquisitions.

Realty Income's portfolio growth 1994 to present.

Image source: Realty Income investor presentation.

Because the company has recently been able to acquire a tremendous number of properties at a low cost of capital, the company's revenue stream should continue to produce a strong level of growth. And because shares have fallen by about 24% since their 2016 highs, now could be an excellent entry point for long-term investors.

Matthew Frankel owns shares of Realty Income. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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