The big news surrounding Realty Income (O 0.55%) in 2021 has been the real estate investment trust's (REIT's) purchase of peer VEREIT. That move cemented this net lease giant's position as the industry's biggest player. However, there has been something even more interesting going on in the portfolio that investors should pay close attention to. Here's a quick look at what that is and why it is so important to Realty Income's future.
A massive shift
In 2019, Realty Income inked a deal to buy 12 stores from Sainsbury's, one of the United Kingdom's largest grocers. The lease term for the properties was 15 years. And the price tag was around $500 million or so, with the retailer expected to account for 2.2% of the real estate investment trust's (REIT) rent roll after it closed the deal. That was a fairly sizable acquisition, but the really important piece was that it represented Realty Income's first foray into Europe.
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Europe has long been a key region for net lease peer W.P. Carey (WPC 0.02%), one of the most geographically diversified REITs you can buy. (Net lease REITs buy single-tenant properties for which the tenant is responsible for most of the operating costs.) Realty Income putting money to work across the pond, however, was notable because it represented a major strategic shift. Never before had the company looked beyond North America's borders. Although W.P. Carey's success in Europe suggested that Realty Income would make out just fine, it wasn't at all clear that Realty Income would find the same success.
It's now a few years later, and it is clear that Realty Income has a strong new geographic opportunity ahead of it. Most recently, it bought a portfolio of assets from Carrefour in Spain. However, this particular grocery store has operations in 30 countries, so it could be an interesting stepping stone into additional markets. This is notable because, during Realty Income's third-quarter 2021 earnings conference call, CEO Sumit Roy was asked by an analyst if anything had surprised him about Europe. His reply: "I do believe that we have been able to create these relationships that have cemented to and have translated into subsequent transactions much more quickly than what we had originally thought."
A very big opportunity
Roy went on to note that European companies are looking for long-term relationships where there's a great deal of certainty that a deal being worked on will cross the finish line. Realty Income's size and financial strength make it an ideal partner in that regard. Indeed, the REIT has a $37 billion market cap and an investment-grade rated balance sheet to back its investment plans up.
But the really exciting news here for investors is that Realty Income believes Europe represents an $8 trillion net lease market opportunity. That's twice the market opportunity of the United States, and only three public REIT players are in the space. Realty Income believes this trio has a combined enterprise value of around $6 billion while net lease REITs in the U.S. have a combined enterprise value of $145 billion. There's huge potential for growth ahead.
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The key here is that Europe is a relationship-driven market, and Realty Income is a perfect long-term partner. What's interesting, however, is that now that Realty Income has acquired VEREIT, it has a massive portfolio of more than 10,000 properties and believes it can take on deals that its peers simply couldn't handle because they are so much smaller. Think about acquisitions that are in the $1 billion size space. So, in an underserved market, it can not only be a trusted partner but also step in and do very big deals. Europe is a massive opportunity that Realty Income looks perfectly positioned to take advantage of. And CEO Roy has already said that companies are quickly recognizing the REIT has a reliable partner.
If you liked it before...
Realty Income's large size will make growth harder to come by in the future, since it takes larger deals to move the needle on the top and bottom line. But its shift into Europe seems to be well timed to address that issue, given the market's size and relative lack of competition. This REIT has done a lot of things well over the years, and it is often afforded a premium price (and thus lower yield) relative to peers. But if its European foray is any indication, it is still finding ways to expand and is earning every bit of that premium.
