Real estate investment trust (REIT) Realty Income (O 1.17%) is a net-lease giant and industry bellwether. Investors often afford it a premium price, and for good reason. Here's why this REIT is such an attractive investment option and why the price Mr. Market is asking right now is probably just a little too high.
Realty Income uses a net lease approach, which means it owns properties whose tenants are responsible for most of the operating costs of the places they occupy. Any single property is high risk, because net-lease assets are generally single tenant. But over a large portfolio, the risk is fairly minimal and operating costs are very low. Realty Income's portfolio includes more than 11,000 properties.
The REIT also has some diversification in its portfolio. While around 83% of its rent comes from retail assets, the rest is from industrial properties. And it has been expanding its reach to Europe.
On the retail side, the portfolio spans across multiple niches with a heavy focus on businesses selling necessities, like grocery stores and pharmacies, and those that are less likely to be impacted by the growing use of online stores, like convenience stores and dollar stores.
On top of that, the company has an investment-grade balance sheet. It has also increased its monthly dividend annually for 27 consecutive years, making it a Dividend Aristocrat. All of this helps to explain why investors have historically rewarded Realty Income with a premium price compared to peers.
The yield recently dipped below 4%. That's toward the low end of the company's historical yield range and suggests the shares are fully valued, if not a little expensive. So there's a tough choice for investors to make here.
One of Realty Income's most important features is its low cost of capital. That comes from having a strong credit rating and a low yield, which is a rough proxy for what it costs to sell equity. Cheap access to money allows the REIT to take on high-quality deals that might not be profitable for competitors that have to pay more for their capital. But there's a fine line here because today's low dividend yield also means investors are "paying up" for the stock, since price and yield move in opposite directions.
Some numbers might help. Over the past month or so, Realty Income's stock has risen 10%. That's more than twice the gain of the average REIT, using Vanguard Real Estate Index ETF as a proxy. The S&P 500 Index is down more than 5% over the same span. It looks like investors are shifting toward high-quality dividend stocks right now. That's not a bad thing per se, but it has pretty quickly moved Realty Income even further into premium price territory.
If you are looking for a reliable dividend-paying stock in a time of market uncertainty, it might be worth it to you to pay up for Realty Income. But it is highly likely that the shares eventually pull back, bringing the yield into a more attractive space -- say, something closer to 5%. A yield in the 6% range, which would require a material sell-off, would make this top-notch REIT very attractive. For a patient investor willing to wait for a more attractive entry point, it's probably best to hold off for now.
Bide your time, if you can
A huge part of investing is about dealing with your own emotions. So it is understandable that investors would be attracted to the consistency that Realty Income offers during a time of uncertainty. And if that's what's going to help you sleep at night right now, then maybe you want to step in here, despite what appears to be a rich valuation.
That said, understand that Realty Income does look fully valued or even a little expensive right now. And if you wait, the price, which has rallied of late, will likely come back down to more attractive levels in time.