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Realty Income Is Fishing for Properties While the Fishing Is Good

By Reuben Gregg Brewer – Sep 17, 2019 at 1:45PM

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Bellwether net lease REIT Realty Income has been making big moves, which is exactly what it should be doing. Here's why.

Real estate investment trust (REIT) Realty Income (O 1.75%) is a dividend investor favorite. A monthly payment coupled with an incredible 26 years of annual dividend increases (putting the landlord into the rarefied Dividend Aristocrat space) are two notable reasons for this. But one negative today is Realty Income's historically low 3.7% yield, suggesting that shares are trading at a premium price. That, however, is good news for existing shareholders, since it helps support the REIT's growth plans.

Here's what Realty Income has been doing lately on that front and why.

A big deal

In early September, Realty Income announced that it was buying 454 properties for a whopping $1.25 billion in cash. The deal was so big that management actually increased its full-year acquisition guidance by as much as 40% to account for the transaction's impact on its original plans. With a portfolio of nearly 6,000 properties, it takes material acquisitions like this to move the needle at the bellwether net lease REIT -- buying one or two small properties just won't make much of a difference at this stage in the company's life. So taking advantage of the opportunity to buy a massive portfolio makes complete sense.

The acronym REIT on a binder with the words real estate investment trust below

Image source: Getty Images

But it isn't the only big move Realty Income has made lately. It also bought a portfolio of 12 grocery stores from U.K. retailer Sansbury in a sale/leaseback transaction in May. That deal was for roughly $500 million -- a notably smaller size, but it was the REIT's first investment outside of North America. The purchase provides Realty Income a material foothold in Europe, opening up a new market to support long-term investment growth. And with 12 properties, Realty Income is making sure it doesn't bite off more than it can chew while it learns the ins and outs of a new market.

Investors should be generally pleased with these two investments. They both help to expand the company's size and reach, and thus its long-term prospects. But there's one more reason to be pleased here: The industry giant is moving while it has access to "cheap" money.

What's your currency worth?

For example, the U.K. deal was partially funded with the proceeds of a bond sale. The interest rate on the bonds was a low 2.73%, with a maturity of 2034. Interest rates are historically low in developed markets around the world, so Realty Income is making use of its investment-grade balance sheet to access low-cost cash to fund acquisitions. That's par for the course, and just good business sense. Big-name companies around the world are issuing cheap debt, too.

But what should really interest investors is Realty Income's stock price, which is near all-time highs (which is, of course, why the dividend yield is near all-time lows). Note that the REIT tapped its revolving credit facility to seal the $1.25 billion September acquisition. That gives it time to decide how it wants to permanently fund the deal. That could mean another debt sale, but it is also likely to mean selling more stock.

O Chart

O data by YCharts

In May, for example, Realty Income sold 12.65 million shares, raising $845 million. The proceeds were used to pay down the revolving credit facility it just tapped to close the $1.25 billion deal. That's a normal occurrence for REITs, which often use short-term financing like credit facilities before permanently funding a deal. Once the latest acquisition is finally consummated, another stock sale is highly likely -- and highly desirable, since the company's stock price is so elevated. It's basically another form of cheap capital.

It's a form of capital Realty Income has been using a lot lately. Over the past five years, the REIT's share count has increased by a whopping 40%. If it were a traditional company, like an industrial, that would be a troubling figure. But for a REIT, which has to pass almost all of its earnings on to shareholders via dividends, it isn't. REITs basically have to issue more shares and sell bonds to raise cash if they want to buy properties because they can't retain cash from earnings to do it. 

This dynamic can be a problem when interest rates on bonds are high and/or when share prices are low (and dividend yields high). But that's just not the case today for Realty Income -- interest rates are low and its stock price is high. And, as you would hope, it is taking advantage of the situation by inking notable deals while "cash" is cheap. 

Not a buy, but...

It's hard to look at Realty Income's stock price today and suggest it is a good value. The historically low yield may make it a good time for the REIT to sell shares, for sure, but it's not such a great opportunity for long-term, value-conscious investors to buy them. However, for anyone who already owns Realty Income stock, seeing that it is using the current environment to get easy access to low-cost capital to invest in the future should be very satisfying. In fact, Realty Income's access to cheap capital is a key competitive advantage right now, and it wouldn't be surprising to see more big deals getting done here. 

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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