As part of its international growth strategy, real estate investment trust Realty Income (O +0.24%) recently announced that it was expanding into Spain. If the company's excellent track record is any indication, there's little reason to expect that the REIT will be unable to find its footing in this new market. And given the trillions of dollars of net lease real estate in continental Europe, this announcement marks another important step toward effectively tripling Realty Income's total addressable market.
So what does this international expansion mean for the real estate investment trust? And is the stock a buy at today's prices?
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A vast new market for Realty Income
Before we discuss the impact of Realty Income's move into Spain, let's look at what led up to it.
Realty Income has expanded from a single Taco Bell location in 1969 to 6,761 properties across all 50 U.S. states, Puerto Rico, and the United Kingdom today. It's the 10th-largest REIT in the world by market capitalization. Until a couple of years ago, Realty Income was entirely domestic, but that changed when it entered the international market with a 429-million-pound ($578 million) sale-leaseback deal with the grocer Sainsbury's in the United Kingdom in 2019.
This international expansion was driven by two major ideas: expanding the company's total addressable net-lease universe and branching out to less saturated net-lease markets to get better deals on quality properties.
Realty Income purchases single-tenant properties and leases them to tenants through triple net leases, in which the tenant covers the property taxes, insurance, and maintenance, as well as the monthly rent. The U.S. net lease market is estimated to be worth $4 trillion, and public net-lease REITs account for about 4% of the total addressable market. But the European market is much larger and far less saturated: It's worth an estimated $8 trillion, with public net-lease REITs accounting for less than 1%.
To achieve the same level of saturation in Europe as in the U.S., REITs would need to acquire roughly $240 billion in net-lease real estate. Executing several billion dollars in acquisitions annually would lengthen Realty Income's growth runway by decades.
Realty Income's expansion from the United Kingdom to Spain opens up many more opportunities. The United Kingdom's commercial real estate market was estimated to be worth $1.5 trillion last year, and the entrance into Spain will open up another market, worth nearly $600 billion last year.
For context, Realty Income's enterprise value was $34.4 billion on June 30. In barely two years of being in only the U.K. to date, Realty Income's European portfolio has already grown to $2.7 billion in enterprise value. This demonstrates that Realty Income's ability to continually expand in the U.S. market has also translated into the U.K. market.
Another strong tenant
Realty Income's entry into Spain comes in the form of a $125 million deal with the country's second-largest grocer, Carrefour. Realty Income locked in a 10-year lease with inflation-linked annual rent increases.
While the deal with Carrefour appears minimal at first glance, it's important to understand that it has over 13,000 stores around the world that could lead to additional acquisitions for Realty Income. And it's another example of what has made Realty Income so successful: its selectivity in acquiring properties. The company predominantly chooses retailers with strong balance sheets in sectors that are non-discretionary (like grocers), have low price points (like dollar stores), or are service-oriented (convenience stores). These characteristics of its portfolio helped it to grow its adjusted funds from operations (AFFO, a key profitability metric for REITs) to $3.39 per share last year, a 2.1% gain, in spite of COVID-19 disruptions.
Carrefour proved its resiliency last year by increasing same-store sales by nearly 8% through the worst of the pandemic. And even better, its portfolio in Spain consists of markets with average household income above the country's median. This should dramatically increase Carrefour's ability to consistently meet its rent obligations in an economic downturn, especially considering that the company pays below-market rents -- which positions Realty Income to renew leases on these properties to Carrefour in the future at higher rents.
This is exactly the kind of tenant that Realty Income wants to develop a relationship with, which is why I believe the REIT's expansion into Spain was well executed.
With the global economy reopening amid increasing vaccination rates, Realty Income expects its growth in AFFO per share to accelerate this year. Its $3.53 to $3.59 AFFO per share guidance for this year works out to a 4.1% to 5.9% year-over-year growth rate.
Quality at a reasonable price
At recent prices, investors can buy Realty Income's stock at 19 times the median of this year's forecast for AFFO per share. This is more expensive than peer National Retail Properties' multiple of 15. But I believe it is justified, since National Retail Properties' AFFO per share experienced a mild COVID-related decline last year while Realty Income churned out another year of growth.
Realty Income's yield of 4.3% at recent prices is still a bit below its 13-year median of 4.5%. But I would argue this is justified by its longer growth runway as a result of its continued international expansion. The company should be able to continue growing its dividend in the years ahead, which will expand on the 26-year streak that already makes it a Dividend Aristocrat. That's because its AFFO per share payout ratio is set to be in the high 70% range for this year, which positions the dividend to grow in line with AFFO per share.
