Dividends are at the front and center of Realty Income's (O +0.71%) business, and not only because it's required to pay out most of its profit since it's a real estate investment trust (REIT). Firstly, the "Income" half of the company's name implies that its shareholders get paid regularly for owning it. Secondly, the retail industry specialist relentlessly advertises its trademarked descriptor: "The Monthly Dividend Company."
But as we've seen over the years, sometimes even the most solid and dependable businesses can crack under strain. The retail sector is facing a monster challenge with the persistent coronavirus pandemic. Perhaps Realty Income's vaunted and seemingly dependable dividend isn't quite as safe as many believe it to be.
Image source: Getty Images.
Real estate royalty
Let's put Realty Income's dividend under a microscope, because -- at least so far -- it's been a good one worthy of study. In fact, several years ago it vaulted the REIT into the hallowed ranks of the Dividend Aristocrats, the few and the proud S&P 500 stocks that have enacted dividend raises at least once annually for a minimum of 25 years in a row.
Realty Income began hiking its once-per-month distribution in 1995, the year after its shares debuted on the stock exchange. Once it got the dividend raise bug, it never sought a cure, at times lifting the payout more than a single time per year (and occasionally distributing a special dividend in addition to that).
It's tough for any business to maintain a stream of regular dividends. It's even tougher to do that every few weeks, instead of once per quarter as is standard for dividend payers. But Realty Income has a few things going for it that give it steady, ready funds for shareholder distributions.
For one, its raises are nearly always incremental, almost always less than $0.01 per share. So yes, it's a Dividend Aristocrat, but at the same time the payout hasn't risen as much as you might suspect.
For instance, from the beginning of 2015 until now, it's crawled from just under $0.19 per share to nearly $0.25 as of its latest declaration on Jan. 11, an increase of less than 32% across that stretch of time. Meanwhile, fellow retail REIT Store Capital has gone from $0.25 to nearly $0.39 -- a 56% improvement.
Realty Income also has a solid growth strategy supporting that slow-but-constant rise in payout. Fueled by habitual profitability, plus cheap sources of funding like low-cost credit and secondary stock issues, it has a big war chest for acquisitions, typically around $3 billion. With this, it's constantly adding to its portfolio. In the third quarter of last year alone, it added 272 properties for a dizzying total of 7,018.
Additionally, the company operates on long-term leases (10 to 20 years in duration), which include regular rent increases. So the pile of money coming into the company is always on the rise.
Cash cushion
This business strategy, at once conservative and generous, has proven to be effective enough that Realty Income didn't have to cut its dividend during the pandemic.
So many other top-flight peer REITs were forced to cut theirs, withered by the pandemic's deleterious effect on the retail industry -- Tanger Factory Outlets and Simon Property Group to name but two (admirably, like Realty Income, Store Capital has so far managed to escape that fate).
Realty Income's business isn't suffering because it's stubbornly insisting on keeping the dividend afloat. It regularly takes in far more than it pays out. Let's look at 2020 and 2021 using the truest measure of profitability for REITs, funds from operations (FFO). All FFO and distribution figures are in thousands of dollars:
| 2021 | Q1 | Q2 | Q3 |
|---|---|---|---|
| FFO available to common stockholders, total | $267,707 | $314,375 | $332,335 |
| Distributions paid to common stockholders | $260,697 | $263,358 | $273,791 |
| Percentage of FFO paid as distribution | 97% | 84% | 83% |
| 2020 | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| FFO available to common stockholders, total | $277,104 | $327,673 | $282,978 | $293,700 |
| Distributions paid to common stockholders | $233,824 | $263,358 | $242,241 | $247,632 |
| Percentage of FFO paid as distribution | 84% | 80% | 86% | 84% |
Source: Realty Income.
Over the seven so-far reported quarters through the pandemic, Realty Income only leaped above the 80s percentage bracket for dividend/FFO ratio once, in the first quarter of this year. Outside of that, it has consistently provided itself enough of a financial cushion to put money in shareholder pockets and have plenty of cash left over.
The return of retail
Meanwhile, many experts say that the omicron variant could represent the peak of the coronavirus. We might not end up beating COVID entirely, but more than a few believe we can soon tame it sufficiently to (more or less) get on with our normal lives. If and when that happens, the retail sector will bounce back powerfully, which will go double for Realty Income as one of its savviest specialty REITs.
At the end of the day, then, I wouldn't worry much about the company being able to at least sustain its dividend. In contrast to rivals like Tanger and Simon Property Group, it's managed to keep it flowing and growing, so it's a good bet it'll be able and willing to continue that well into the future.
