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Realty Income Is the Gift That Keeps on Giving

By Kody Kester – Dec 9, 2021 at 7:45AM

Key Points

  • Realty Income's business model helped the company navigate last year's challenges.
  • The stock's payout is well covered by the AFFO per share that its portfolio is generating.
  • Realty Income may not be the cheapest REIT, but its quality makes it worth the price for income investors.

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Last month, the triple net lease REIT stuffed its shareholders' stockings early with a 4.2% hike to its monthly dividend.

As an income investor, does it get any better than when one of your stocks pays you a stable dividend each quarter? The answer is yes, it can get better -- when that stock is instead a monthly dividend payer. An added bonus is monthly dividend payers give you cash flow that better aligns with how most people pay bills, i.e. monthly.

But it can't get any better than that, right?

Actually, the best dividend stocks are the ones that pay you each month and reliably grow with each passing quarter. Real estate investment trust (REIT) Realty Income (O 0.58%) recently upped its monthly dividend by 4.2% from the previous $0.236 per share to $0.246, and by 5.1% compared to the dividend payment last December.

A stocking filled with cash.

Image source: Getty Images.

This raises the following two questions: What is the secret sauce behind Realty Income's track record as the only Dividend Aristocrat to pay a monthly dividend? And is the stock a buy following its recent payout increase? 

A steady, expanding business

The first reason that Realty Income can pay its monthly dividend like clockwork is due to the reliable business model. Because tenants sign triple net lease contracts with Realty Income on its approximately 7,000 properties, the tenants pay property taxes, insurance, maintenance, and utilities, in addition to a monthly base rent amount to the REIT each month. 

Secondly, these contracts are very favorable to the company. Realty Income's weighted average lease term is 8.8 years, which gives the company dependable cash flow well into the future at any given time. 

And since approximately 85% of Realty Income's leases include built-in rent escalators that are either tied to inflation or fixed increases, the company generates adjusted funds from operations (AFFO) per share growth right off the bat. 

Finally, Realty Income's increasing international presence means there is plenty of growth left in its tank. That's because only 9.9% of the company's annualized base rent (ABR) was generated outside the U.S. as of the third quarter. Also, Realty Income's addressable commercial real estate market in Europe is $8 trillion, double that of the U.S.

These factors help to explain why Realty Income is anticipating a significant acceleration in its AFFO per share growth from 2.1% last year to 5.5%, based on its midpoint guidance for this year of $3.58.

The dividend is backed by a conservative payout ratio

At a glance, Realty Income's business model of consistently growing monthly cash flow lines up well with its monthly dividend obligation. But just how well covered is the dividend that the company was confident enough to announce such a strong raise in its payout?

Well, Realty Income's dividend payout ratio for this year will be around 79% based on its midpoint guidance. Given that Realty Income's AFFO per share has grown in 24 of the past 25 years (with the exception being the Great Recession year of 2009), the stock's payout ratio appears to leave a large-enough cushion to endure even the harshest operating environments.

And with Realty Income's completion of its accretive VEREIT acquisition last month, the company anticipates that its AFFO per share will grow 9.2% from this year to the next based on its midpoint guidance for each respective year. 

As a result of such high growth, Realty Income could grow its payout over this year at a healthy 6% clip and actually see its dividend payout ratio dip to approximately 77% next year. In other words, the company can continue growing its dividend in the mid-single digits annually for the foreseeable future.

A fair price to pay for quality

Realty Income isn't the cheapest retail-oriented REIT, but a premium is to be expected for a stock with a storied track record. Realty Income's price-to-AFFO per share multiple of just under 18 based on next year's midpoint guidance is higher than peer STORE Capital (STOR), which trades at an AFFO-per-share multiple of less than 16.

STORE Capital's 9.3% midpoint AFFO per share growth guidance for next year is in line with Realty Income's. However, the latter grew its AFFO per share in the early days of the pandemic last year, whereas the former saw a slight decline.

This key distinction and Realty Income's superior scale (STORE Capital owns just under 2,800 properties) are what I believe justifies the stock's premium to peers. And as shareholders sit back and let Realty Income deliver 5% to 6% annual AFFO per share growth, as it has done throughout its history as a public company, generous dividend growth should also keep up going forward. A solidly growing 4.3% dividend yield is an attractive proposition, which makes Realty Income an excellent stock for income investors to buy for their portfolio. 

Kody Kester owns shares of Realty Income and STORE Capital. The Motley Fool recommends STORE Capital. The Motley Fool has a disclosure policy.

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