I love collecting passive income. There's just something about getting paid even though I didn't do any work to earn that money. However, passive income brings more than joy. It has given me a tremendous amount of financial flexibility and has me on the path toward financial freedom.
One of my favorite places to generate passive income is investing in real estate investment trusts (REITs). The sector typically offers above-average income yields that steadily rise over time. A great REIT for beginners is Realty Income (O -0.79%).
Image source: Getty Images.
What is Realty Income?
Realty Income is a REIT that focuses on owning freestanding properties that it leases to a single tenant under a net lease agreement. That lease structure makes the tenant responsible for maintenance, building insurance, and real estate taxes. As a result, Realty Income earns steady rental income.
The REIT currently owns around 11,280 properties in the U.S. and Europe leased to about 1,090 clients in over 70 industries. It primarily focuses on owning properties leased to high-quality tenants in the retail and industrial sectors that are recession-resistant and isolated from the pressures of e-commerce. These include grocery stores, pharmacies, home improvement stores, quick-service restaurants, and warehouses. This diversified portfolio helps reduce risk, further stabilizing Realty Income's rental revenue.
Another key characteristic of Realty Income is its financial strength. It has a reasonable dividend payout ratio for a REIT at around 75% of its adjusted funds from operations (a proxy for cash flow). That enables it to retain about a quarter of its income for reinvestment. Realty Income also has one of the highest credit ratings in the REIT sector. That gives it tremendous financial flexibility as it can borrow money at lower rates.
An amazing passive income producer
Realty Income's low-risk business model and conservative financial profile have enabled the company to deliver dependable income to its shareholders over the years. The REIT has paid an impressive 623 straight monthly dividends since its formation 53 years ago. Meanwhile, Realty Income has increased its dividend payment 115 times since its public market listing in 1994, including growing it in each of the last 98 consecutive quarters. Overall, Realty Income has expanded the payment at a 4.4% compound annual rate.
That growing dividend has added up over time. For example, someone who purchased 100 shares a decade ago ($3,496 investment) would have collected $174.60 in dividends that first year, or a 5% yield on their original cost. Fast forward 10 years, and that same investment would generate $296.40 of annual income, good for an 8.5% yield on the initial cost. Meanwhile, the cumulative passive income over the last decade is now up to $2,707 or 77% of the original investment.
More passive income growth ahead
Realty Income should be able to continue growing its dividend in the coming years. The REIT estimates that there's upwards of $12 trillion of owner-occupied commercial real estate in the U.S. and Europe. That leaves it with a vast opportunity set of income-producing properties it can buy in the future to help grow its rental income stream. It's targeting to purchase at least $5 billion of properties this year alone.
Meanwhile, the REIT has ample financial flexibility to fund its continued expansion. It retains about a quarter of its rental income for reinvestment purposes and has one of the best balance sheets in the sector to help finance growth. Realty Income will also sell stock to fund deals and maintain a strong balance sheet.
A great way to start earning passive income
Realty Income has one of the lower-risk business models in the REIT sector, which helps improve income sustainability. Meanwhile, it has a phenomenal growth track record that isn't likely to end anytime soon. Those features make it an ideal investment for those looking to begin collecting passive income.
