Is the Worst Over for Realty Income?

All eyes were on net-lease real estate investment trust (REIT) Realty Income (O 0.11%) during the COVID-19 shutdowns. An industry bellwether, the company's performance wasn't particularly reassuring at the beginning of the pandemic. But here are the stats you need to know to understand why the worst is likely over for this industry giant.

It got ugly

With over 6,500 properties, Realty Income is easily one of the largest net-lease real estate investment trusts you can buy. Net-lease properties are interesting in that the lessee is responsible for most of the operating costs of the properties they occupy, making it a fairly low-risk business for the landlord. While an oversimplification, Realty Income basically just has to sit back and collect rents. 

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In normal times the key number to watch is occupancy, which has long been in the high-90%s at Realty Income. In fact, occupancy had never fallen below 96% at the REIT, even during the deep 2007-to-2009 recession. Only this time around, the downturn was different. The recession that started in February was driven by the government-mandated closure of non-essential businesses. Realty Income generates around 85% of its top line from retailers, many of which ended up shut down during the early days of the pandemic. 

Without sales, many of its lessees stopped paying rent. Rent collection quickly became the most important number to watch, since an occupied property with a non-paying tenant is basically no different from an empty property. In April Realty Income's rent collection dropped to 83%. May's rent collection was 82%. Although the rent collection number was fairly steady, the fact that the REIT was missing nearly 20% of its rent roll was a very big deal for investors. Despite a long and impressive history of dividend payments behind it, Realty Income couldn't possibly support its current payout with nearly a fifth of its tenants not paying rent. 

A turn for the better

That's why June's nearly-86% collection rate was such a relief to see. In fact, the early rent collection rates for April and May had improved by the time the REIT reported second-quarter earnings, allowing the quarter's rent collection rate to come in at roughly 85.5%. And things have only gotten better since. 

In July rent collections totaled about 92%, with August coming in at 93.5%. Realty Income's business has clearly rebounded as the economy has continued the reopening process. In fact, in a show of strength, the REIT even increased its dividend in June. 

Data source: Realty Income

When you step back and look at the trouble spots in the portfolio, meanwhile, you get a better picture of the issue. The two industry segments in the highly diversified portfolio with the worst payment rates were movie theaters and gyms. Both are places where people congregate in groups for long periods. As these two segments have now begun to reopen, the future should start to improve on the rent collection front.

The numbers bear that out. In the April-through-July span, rent collection from gyms was just 58%, but in August the rate increased to 88%. At movie theaters the improvement was from a dismal 7% to a still-troubling 27%. However, it was only recently that movie chains really started to open for business again, so those numbers are likely to keep improving. Still, investors might want to keep a close eye on this particular segment in the months ahead, just in case. 

Definitely on the upswing

There are always puts and takes in a portfolio of properties, but it is pretty clear Realty Income's biggest trouble spots are starting to see improvement. And that's had a notable impact on its overall rent collection rates. There could still be some more bad news to face because of COVID-19, but the economic reopening process appears to have put the REIT's rent collection rates back on the right path. The worst does, indeed, appear to be over, even if long-term investors should be prepared for the road to remain a little bumpier than usual in the months ahead.