One hallmark of a great company is that it can grow its profits regardless of the operating environment, as well as consistently increase its dividend, if it pays one. Realty Income (O 0.11%) checks off both boxes easily. The real estate investment trust (REIT) has raised its dividend for 26 consecutive years, and it's the only monthly payer among the Dividend Aristocrats (a group of companies that, like Realty Income, have increased their dividend at least 25 straight years and are included in the S&P 500 index).
Realty Income's track record is impressive enough, and we'll get to that soon. But I think that the company can easily keep paying investors rising dividends thanks to its massive size and scale, as well as a large pipeline of high-quality acquisition candidates. These factors set Realty Income apart, and they make it a great buy.
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The undisputed leader of a stable business model
Realty Income acquires single-tenant properties and rents them out to tenants via triple net lease agreements. In a triple net lease, tenants pay for property taxes, maintenance, and insurance, as well as utilities and base rent. Realty Income is the largest net lease REIT by market capitalization -- almost $28 million at Monday's prices. Its lease agreements are often for 10 to 15 years and include annual rent increases or escalators, which help Realty Income to grow organically and keep up with inflation before factoring in its acquisitions.
As of the second quarter of 2021, Realty Income owned 6,761 properties located in the U.S., Puerto Rico, and the U.K.
While 84% of Realty Income's annualized base rent (ABR) comes from retail, it's much more reliable than you'd expect from the retail industry. That's because this ABR came from tenants who set themselves apart from other retailers by offering non-discretionary products (e.g., groceries), low price point products (e.g., dollar stores), and/or service-oriented retail (e.g., convenience stores). Realty Income points out that these business models are more resistant to economic downturns and more immune to e-commerce pressures.
Realty Income's approach was most recently vindicated in the early phases of the COVID-19 pandemic when it collected 86.5% of its rent for Q2 2020 (its low point during the pandemic). That's why Realty Income actually increased its earnings power during the worst of the shutdowns, growing its adjusted funds from operations (AFFO) per share 2.1% from $3.32 in 2019 to $3.39 in 2020. (AFFO is the REIT equivalent of earnings.) Realty Income's rent collection reached 99.4% this July as vaccinations became widespread and economies and businesses reopened.
The ongoing economic recovery and Realty Income's $2.2 billion in acquisitions to date this year led the company to raise its AFFO-per-share guidance from the previous outlook of $3.44-$3.49 to $3.53-$3.59. The midpoint of Realty Income's updated outlook would reflect 5% year-over-year growth in AFFO per share, which is solid for such a large REIT.
Plenty of room for growth
Realty Income has made $2.2 billion in acquisitions to date, which is possible because its pipeline of potential deals is in the tens of billions of dollars. For context, Realty Income sourced $57 billion in potential acquisition volume during 2019. Through the first half of this year, Realty Income has already sourced $40 billion in potential acquisition volume.
Realty Income's higher sourcing volume is what prompted management to increase its acquisition guidance for this year to a record $4.5 billion. This is considerably higher than the company's previous record of $3.7 billion in acquisitions during 2019, which suggests AFFO/share growth will accelerate for the foreseeable future.
Realty Income's increased sourcing volume is the result of its decision to enter the United Kingdom real estate market in 2019. This has allowed Realty Income to become even more selective in securing quality tenants for its properties, reducing acquisitions from 7% of sourced volume in 2019 to just 5% in the first half of this year. Even though Realty Income didn't pull the trigger on nearly $38 billion of property sourced this year, this means that the company can be even more selective with potential tenants, which is exactly what has occurred to date.
In other words, not only will Realty Income be able to deliver mid-single-digit annual growth in AFFO per share in the years ahead, but that growth will be of even higher quality than before via better tenants. This will strengthen the company's ability to withstand economic downturns, pandemics, and so forth even more in the future.
This increased earnings power and quality should also translate into steady mid-single-digit annual dividend growth as well, which is something that income investors should like.
A reasonably priced REIT
Realty Income isn't the most cheaply priced REIT. STORE Capital, another favorite of REIT investors, trades at 18 times this year's guidance at recent prices, compared to Realty Income's 20 times.
However, Realty Income arguably proved itself to be higher quality than STORE Capital. This is because while STORE Capital experienced a slight decline in AFFO per share last year, Realty Income grew its AFFO per share.
Realty Income's 4% dividend yield, coupled with mid-single-digit annual AFFO per share growth, should realistically deliver modest but steady total returns for investors while providing stable monthly income.
