Income investors are facing a pretty limited menu of investment options these days with short-term interest rates hovering around 0% and the economy still in recovery mode. Several companies that were known for paying dividends had to suspend them this past year to manage the adverse economic conditions. These investors looking for alternatives should take a close look at the real estate investment trust (REIT) sector since these stocks tend to be reliable dividend payers.
Realty Income (O 0.82%) is one of the Dividend Aristocrats, which is a select group of S&P 500 companies who have raised their dividend payouts every year for at least 25 straight years. Realty Income is confident enough about its dividend payout history to trademark the moniker "The Monthly Dividend Company" to describe itself.
Triple-net leases are a different business model
At the end of 2020, Realty Income owned 6,592 properties, over 99% of which were single-tenant, in the United States and the United Kingdom. Realty Income is a triple-net lease REIT, which gets its name from the type of leasing arrangement it favors that stipulates the tenant cover additional expenses like insurance, taxes, and maintenance.
These leases are generally longer-term (over 10 years) and have automatic rent escalators built into them. This model works best with tenants in highly stable businesses, and it differs from the more common gross-lease model, where the landlord bears most of these costs. A typical strip mall lease would use the gross-lease model.
Realty Income focuses on stable, defensive companies
Realty Income focuses on tenants that are generally insensitive to the overall economy. Most of Realty Income's tenants are in the retail business, however, the company does lease out industrial properties. The largest tenants are highly stable, defensive companies like Walgreen's, 7-Eleven, Dollar General, FedEx, and Dollar Tree.
Realty Income did see some weakness in rent payments during the COVID-19 lockdowns, although most of its tenants were considered essential businesses. Movie theaters were the one big weak spot, but child care, restaurants, and fitness were all affected by the disease outbreak. Realty Income collected about 93.6% of all rent in the fourth quarter, and investment-grade clients all paid.
Despite COVID-19 challenges, funds from operations rose
Despite the challenges from the COVID-19 lockdowns, Realty Income reported a 10.7% increase in revenue in 2020 compared to 2019. Funds from operations (FFO), which is how real estate investment trusts usually report income, rose 9.9% to $1.1 billion compared to $1 billion in 2019. FFO per share rose 0.6% to $3.31 per share. Given how challenging the COVID-19 crisis has been for REITs and retailers, being able to report increasing FFO is quite the accomplishment. Note that GAAP earnings per share did fall as the company increased its reserves for potential future losses. Since these reserves were noncash (that is, they impacted earnings, but don't represent actual cash losses) they aren't included in the FFO per-share calculations.
At current levels, Realty Income is trading at 18.6 times 2020 FFO per share, which is a reasonable valuation. The stock also has a pretty decent yield of 4.6% if you annualize its latest monthly dividend. Realty Income has been around since 1969, so the company has seen some difficult economic cycles. The company's durable business model, combined with a stable tenant base, makes Realty Income a forever stock for an income investor's portfolio.