Real estate investment trusts (REITs) were hit hard by the coronavirus shutdowns, but some have done better than others. Net-lease REIT Realty Income (NYSE:O), for example, has turned in strong numbers after a notable hit early in the pandemic. That's not a shock for this industry bellwether, but don't take that as a reason to buy shares -- in fact, peer W.P. Carey (NYSE:WPC) is probably a better long-term bet as a new year gets underway. Here's why.
COVID-19 performance was strong
The pandemic was a real litmus test for real estate investment trusts. While some sectors were doomed to have terrible performance (like hotels), others (net lease) were a mixed bag -- REITs with resilient business models shined, while those with fragile models struggled. For example, EPR Properties, which owns things like amusement parks and movie theaters using a net-lease model, has struggled mightily because of its unique experiential focus. It is still only collecting around half of the rents it is owed.
Realty Income, on the other hand, saw rent collection dip to around 80% in the early days of the pandemic. However, collections are back up to around 94%. So, relatively speaking, Realty Income has handled the downturn well. But W.P. Carey's rent collections never dipped below 96%, and are currently at 99% or so. Basically, when times got tough, W.P. Carey proved it had an even stronger model than Realty Income.
The business plan benefits from diversification
The key to W.P. Carey's success is its focus on diversification. Realty Income's portfolio is heavily focused on the retail sector, which accounts for roughly 85% of its rents. The rest is spread across industrial (10% of rents), office (3%), and agricultural (the remainder). And it generated around 4% of its rents from the United Kingdom as well. Compare that to W.P. Carey's mix of industrial (24% of rents), warehouse (23%), office (23%), retail (17%), and self-storage (5%) assets (a sizable "other" component makes up the difference). In addition, roughly 37% of W.P. Carey's rent is derived from outside the United States, largely from Europe.
You know diversification is good for your portfolio, but it can be just as beneficial for a REIT's portfolio. W.P. Carey's success during the pandemic is evidence of this and sets it apart from Realty Income, which is much more focused in its approach.
Dividend yield illustrates a history of growth
So W.P. Carey has held up better than Realty Income, and you might expect investors to reward it for that. But that doesn't seem to be the case when you look at the dividend yields these two REITs offer. Realty Income's yield is 4.6% or so, while W.P. Carey's yield is 5.9% -- more than a full percentage point higher. While some might suggest that investors are giving Realty Income some additional credit for its 27-year streak of annual dividend increase, W.P. Carey has increased its dividend every year that it has been public (23 years and counting). The two REITs really stand toe-to-toe when it comes to dividend histories.
Valuation is a bargain by comparison
The next issue to consider is valuation. Realty Income's price to adjusted funds from operations (FFO) ratio is around 19 times, using the REIT's third-quarter results as a run rate. That's a big number for a company that's basically a slow and steady tortoise. W.P. Carey's price to adjusted FFO is closer to 15 times, using the third quarter as a run rate. That's not exactly at bargain levels, but it is a lot more compelling than Realty Income's valuation.
Reliable dividends, reasonable price
Realty Income is a well-run company, but you'll probably be better off avoiding the "default" choice in the net-lease space and looking at strong alternative W.P. Carey. It has a good business model (perhaps even better than Realty Income's), a strong performance history, a robust yield, and a more reasonable valuation. It wouldn't be fair to suggest investors should dislike Realty Income, but when you step back there are some pretty good reasons to prefer W.P. Carey.