The global economy took a huge hit in early 2020 as the coronavirus spread across the globe, leading to a sudden bear market in the United States. Although not immune to the impact, net-lease real estate investment trust (REIT) Realty Income (O -0.78%) continued to pay its monthly dividend without a hitch. It even increased the payment. Dividend investors worried about the next market crash should consider buying Realty Income -- just make sure you understand one key issue.
How it did
Realty Income owns single-tenant properties with long-term leases that require tenants to pay most of the expenses of the buildings they occupy. This is known as a net lease, and it's a fairly conservative way to invest in real estate. These transactions end up being more of a financial arrangement than anything else, in which a company with important property looks to raise cash via a sale leaseback. Essentially, in order to maintain access to a vital property, the seller immediately signs a long term lease. The leases usually include regular rent increases.
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While not every deal works out well, these properties are normally very important for the lessees. Thus, when times get tough, like they did in early 2020, renters aren't looking to cut and run -- they will do everything they can to pay the rent, or they'll look to work out a deal. At the worst of the COVID-19 downturn, Realty Income's rent collection rate fell into the low-80% range. By September, however, collections had improved to roughly 94%.
Obviously 100% would be ideal. However, given the severity of the pandemic and the government's actions to close non-essential businesses and enforce social distancing among consumers, Realty Income is showing a fair amount of strength. Backing that up was the real estate investment trust's decision to increase its dividend in each of the first three quarters of 2020. The amounts were small, but they were shows of strength on the part of the company.
Great company versus great investment
Simply put, Realty Income has proven it can handle adversity. That's why its annual streak of dividend hikes is 27 years long. That's Dividend Aristocrat territory, placing the REIT in rare company. For extremely conservative types, there's a good reason to take a deep dive here. But there's a big trade-off you'll be making, and you need to know that going in.
Realty Income's dividend yield is roughly 4.6%. That's higher than the yield of the average REIT, using Vanguard Real Estate Index ETF as a proxy, which offers a 3.7% yield. However, it is toward the low end of Realty Income's historical yield range. To be fair, the yield has been notably lower over the past decade. In fact, the current yield is probably middle-of-the-road if you are looking at the last 10 years. But using yield as a rough proxy for valuation, the REIT is definitely not cheap.
O Dividend Yield data by YCharts
Looking at that another way, Realty Income's price to adjusted funds from operations (AFFO) ratio is around 17.5 today. That's roughly akin to a price to earnings ratio for an industrial company. Realty Income's Price to AFFO ratio has been over 20 at times, so the number isn't as high as it has been. But 17.5 is still fairly high for what is basically a conservative, slow-growing dividend stock.
So investors with a heavy value bias will probably not be pleased with Realty Income. However, there's another angle here for highly conservative dividend investors. If you are worried about market turmoil and the impact it could have on the income you generate from your portfolio, Realty Income's impressive history of dealing with adversity could be worth the price of admission. You simply need to be aware that you are paying a premium for the privilege of owning this REIT.
Nothing's perfect
Every investment is a trade-off, because every company has flaws. The biggest problem with Realty Income is that investors are well aware that it is a well run REIT, and have bid the stock up accordingly. It's pretty much never cheap except when the markets are in a massive state of turmoil, so buying at those points would clearly be better than buying today. But it's hard to pull the trigger when the world appears to be falling apart.
So, for conservative investors looking for a steady dividend payer, Realty Income appears to be trading at a fair-to-only-slightly-expensive price point. That's worth considering if dividend consistency is your biggest concern.
