Here's Where Things Went Wrong for Realty Income Corporation Stock in 2017

How Realty Income (O 0.52%) performed in 2017 is a good example of how stock prices don't necessarily match up with fundamental business performance in the short run. Even though the real estate investment trust had a strong year from the perspective of producing growth and solid income streams for its shareholders, Realty Income's own share price didn't reflect that success, saddling investors with a net total return of just 4%. Without its lucrative dividends, shareholders would have suffered losses.

Before you count Realty Income out, it's important to understand what contributed to the stock's subpar performance. With many things about the REIT still looking encouraging, letting a single year's returns influence your decision-making too much would be a mistake -- especially as Realty Income keeps looking to expand in 2018.

Image source: Realty Income.

Stats on Realty Income

Source: Realty Income investor relations.

What's gone right for Realty Income?

Before turning to the causes for the REIT's poor stock price performance, Realty Income's successes are worth discussing. As you can see above, Realty Income is still producing double-digit percentage growth on key metrics like revenue and adjusted funds from operations, which is a more accurate measure of earnings power for real estate investments.

Realty Income has done well to sow seeds for future growth. The company announced $265 million in acquisitions in the third quarter of 2017, bringing its year-to-date total to $957 million. The REIT has also done a good job of managing its existing portfolio of properties, with occupancy rates at 98.3% and recapture rates from releasing operations exceeding 100% for the fifth quarter in a row. In order to finance its expansion, Realty Income has selectively issued new shares, but even the resulting dilution hasn't eliminated the real estate specialist's bottom-line growth on a per-share basis.

So why is Realty Income stock falling?

Despite Realty Income's overall success, the stock hasn't shared in the gains that the overall market has seen in the past year. One big portion of that has to do with ongoing concerns about the impact of the retail industry on the real estate market. Realty Income has substantial exposure to retail real estate in its investment portfolio, and the store closings that many major department stores have announced in recent years has had a dramatic impact on anchor locations at shopping malls that have contributed to falling traffic in many areas. The rise of e-commerce has made it less important for stores to have a physical presence, and customers increasingly like the convenience of shopping online compared to having to trudge out to a brick-and-mortar store.

The other hit that Realty Income has seen lately is on the interest rate front. The Federal Reserve raised short-term interest rates three times in 2017, and many experts see the central bank sustaining that pace of rate hikes throughout 2018 as well. For a substantial part of 2017, the rise in the Federal Funds rate didn't lead to corresponding increases in long-term Treasury yields, but in the past couple of months, those rates have drifted upward as well. The value of most income-producing investments suffers when rates on competing Treasuries go up, and that's contributing to the REIT's poor performance.

Yet Realty Income has answers to both of those concerns. Realty Income focuses most of its retail exposure on freestanding single-tenant properties rather than integrated shopping malls, and being selective in its choices of tenants has helped insulate the REIT from the worst of the retail sector's pain. Interest rates do hurt REIT share prices, but Realty Income's steadily growing payouts distinguish its shares from competing fixed-income investments that truly do fix income at a stagnant level.

Look for more of the same in 2018

Rising rates and retail concerns aren't likely to go away this year, and Realty Income could therefore continue to experience less than stellar share price performance. Yet the REIT's fundamental business prospects are sound, and Realty Income should keep delivering strong returns for long-term shareholders over time.