The current interest rate environment makes it difficult for income investors to find decent yield. With the credit markets awash in cash, bonds often have a pretty lousy risk/reward ratio.
That said, income investors should take a close look at real estate investment trusts (REITs), where they can still find strong companies that pay consistently and raise their dividend regularly. Realty Income (O -1.47%) is one of the first companies that should come to mind.
Let's find out a bit more about this REIT and its dividend potential.
An aristocratic choice
Realty Income is a Dividend Aristocrat -- an S&P 500 company that has raised its dividend, year in and year out, for at least 25 consecutive years. It is also one of those rare companies that pays out monthly dividends and is proud of that fact, having trademarked the name "The Monthly Dividend Company." It has made 93 consecutive quarterly increases to its dividend. This steady performance makes it a great staple for an income investor's portfolio.
As of March 31, Realty Income owned 6,592 properties with over 114 million square feet of space, focusing on stand-alone buildings with one tenant. It's a "triple net" lease company, which means that tenants are responsible for most expenses, including insurance, taxes, and maintenance. These leases are generally long-term (around 10 years) and include automatic rent escalators. This means that the tenant's credit profile has to be exceptionally strong to make that sort of commitment.
Realty Income has a super-stable tenant base
Part of what makes a tenant's credit profile attractive is how sensitive it is to the vicissitudes of the economy. The ideal tenant is unaffected by recessions or even COVID-19 lockdowns. Think drugstores, dollar stores, and convenience stores, as opposed to apparel stores and restaurants. In 2020, Realty Income's biggest tenants were Walgreen's, 7-Eleven, Dollar General, FedEx, and Dollar Tree.
During the 2020 COVID-19 lockdown, Realty Income had strong rent collections and lower vacancy rates than the typical mall REIT. Most of its tenants were considered essential businesses, although the company was negatively affected by closures in movie theaters, gyms, child care, and restaurants. While collections did fall during the year, the REIT closed out 2020 with a 93.6% collection rate and ended the first quarter of 2021 at more than 94%. Theater tenants represented 5.6% of contractual rent at the end of 2020, and Realty Income had collected only 14% of their contractual rents. With the COVID-19 restrictions ending and vaccinations continuing, expect to see improvement in this part of the business.
One of the few REITs that increased earnings last year
Despite the effects of COVID-19, Realty Income still reported an increase in adjusted funds from operations (AFFO) per share compared to 2019. Most REITs -- including apartments, offices, and malls -- reported decreases in AFFO per share. AFFO is the preferred method for measuring a REIT's earnings since it removes a lot of non-cash charges like depreciation and amortization that understate the cash flow generation of the assets.
At current levels, the company is trading at 19 times its guidance for 2021 AFFO per share, which is reasonable for a high-quality REIT. If you annualize its current monthly dividend of $0.235 per share, the dividend yield is 4.2%. With Realty Income, you get both stability and yield, which is hard to come by these days. For this reason, it should be one of the first REITs a dividend investor should consider.