Realty Income (O 0.52%) completed its acquisition of VEREIT in late 2021, dramatically increasing its portfolio size to over 11,000 properties. That transaction provided it with a scale that none of its net lease peers can match. Now, in early 2022, it has announced a new acquisition that again changes the dynamics of the company's portfolio, only in a different way. Here's how investors should think about Realty Income's $1.7 billion Encore Boston Harbor deal.
Bold moves
Realty Income is a bellwether net lease real estate investment trust (REIT). Net lease REITs own single-tenant properties for which tenants are responsible for most of the operating costs of the assets they occupy. Although any single property is a high-risk proposition given that there's only one tenant, a large portfolio can offset any single-unit vacancies. With more than 11,000 properties in Realty Income's portfolio, most of which are retail focused (roughly 83% of rent), the risks here are fairly low.
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That said, one of the key reasons for the company's recent acquisition of peer VEREIT was to scale up so it could take on more sizable deals that its peers couldn't manage. That's exactly what the agreement to buy Encore Boston Harbor for $1.7 billion from Wynn Resorts represents. It's a massive property acquisition that smaller net lease peers couldn't have pulled off. And while there are casino-focused net lease REITs, Realty Income's move brings this niche asset class into the mainstream net lease space.
That said, it isn't the first time Realty Income has stepped into a unique area, noting that it also owns a portfolio of vineyards, which make up around 1% of rents. To be fair, the vineyard investment was more of a special situation than the casino deal, but it highlights that the current move is not as far out of the norm as it might at first seem. Realty Income can and has acted opportunistically outside its core when there's a good deal.
The pros and cons
The biggest risk here is probably the size of the transaction, which at $1.7 billion is fairly large for a single property. Notably, the REIT has highlighted that the casino will make up less than 3.5% of its portfolio once the transaction is fully consummated. At first blush that sounds like a good thing, but step back and consider this relative to the rest of the portfolio. Within Realty Income's 11,000-plus portfolio, one single investment will account for around 3% of rent. That's a huge amount of concentration in a single asset. Moreover, Wynn Resorts will instantly become one of the REIT's top five tenants. Again, thanks to a single asset. This is a material change of direction for Realty Income, which has long focused on diversification.
And yet there are positives. For example, the lease on this property will be for 30 years. That's a huge number compared to the company's current average lease length of roughly 11 years. There are annual rent escalators built in, as well, and an option for a second 30-year term. This could be a very attractive asset for a very long time.
On that score, Encore Boston Harbor is a unique property. It is located in a major city in a state that has only agreed to approve three casino licenses (only two of which have been issued). Encore Boston Harbor has recently opened a sports betting venue, an area of the casino industry that is growing quickly as sports betting becomes legalized. For all intents and purposes, this is a very interesting asset for Realty Income to own.
Meanwhile, it's notable that casinos held up relatively well during the pandemic, continuing to pay rent to their landlords despite the forced closures they experienced. Indeed, the recession in 2020 was no normal downturn, and it showed that the casino asset class is resilient to massive headwinds.
What now?
Casinos are highly regulated properties, so the deal will take a while to close. And, all in, it seems like a good move. Still, the scale of this single property makes it a risk that investors should closely monitor. It will also be important to watch the company's future investments, since adding more casino properties could quickly change the portfolio in dramatic fashion. In other words, so long as Realty Income doesn't go too far into the casino space, Encore Boston Harbor looks like a win.
