The economy has been on a roller coaster since the pandemic began in 2020. It was strong heading into the pandemic, which then ushered in a short, deep recession. Heavy stimulus payments followed, which unleased inflation, and now the U.S. could be in (or entering) a recession. This is a lot for any company to handle.
Income investors tend to be older and therefore have less ability to bear volatility, so Realty Income (O 0.28%) is a great stock for them: It has a highly stable business model and a decent yield as well. Here's why you may want to consider it for your portfolio.
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How triple-net leases differ
Realty Income is a real estate investment trust (REIT) that focuses on single-tenant stand-alone properties under a type of arrangement called a triple-net lease. Most leases that renters are familiar with are gross leases: The tenant is responsible for paying rent, and the landlord handles most other expenses such as taxes, insurance, and maintenance. The typical apartment lease is a gross lease.
Under triple-net leases, the tenant bears these costs. These leases are much more common for stand-alone properties such as industrial warehouses and single-tenant retail stores. Triple net leases are generally longer-term agreements and contain some form of annual increases. Both sides benefit from the certainty these arrangements provide.
Realty Income has just about seen it all economically
Realty Income has been around since the late 1960s and has been through all sorts of different economic environments. It was able to navigate the financial crisis, the pandemic, and is now dealing with inflation like we really haven't seen for 40 years.
The REIT's secret sauce is its tenant base. Its typical tenants are in highly defensive industries, which means they are largely insulated from economic downturns. The ideal tenant for Realty Income is a drugstore, convenience store, or dollar store. Even if the economy enters a deep recession, people still buy medications and snacks, and they look to save money.
In 2020, during the height of the pandemic, Realty Income increased its dividend three times, while most other REITs were cutting theirs. Most of the company's tenant base was in businesses considered essential, and thus its tenants were permitted to remain open. It did have some tenants like theaters and fitness centers that struggled, but overall the company navigated the crisis about as well as could be asked.
Rising rates and inflation seem to be nonissues
So far, rising interest rates and inflation have yet to hurt the company. Realty Income recently reported that adjusted funds from operations (AFFO) per share rose 10.2% in the quarter. Funds from operations are a REIT-centric financial measure frequently used to describe earnings. Since REITs have a lot of depreciation and amortization (which are noncash charges), earnings under generally accepted accounting principles (GAAP) tend to understate the cash flow capacity of the company. AFFO does a better job of that.
Interest rates have been rising, and that is usually a tougher environment for the consumer and retailers. Despite the increase, occupancy has been increasing and stands at 98.9%, the highest in 10 years. The company is expanding its overseas operations, and increased its guidance for property acquisitions to over $6 billion for this year. It also increased guidance across the board. Suffice it to say that increasing rates and inflation are not an issue for the company, at least so far.
Realty Income is a Dividend Aristocrat, which means it has at least a 25-year record of consecutive annual dividend hikes. It recently increased its monthly dividend in June and now yields 4.1%. While there are REITs that yield more, Realty Income is a world-class triple-net lease REIT and should have a premium multiple. The $2.97 annual dividend is well covered given the company is guiding for AFFO to come in between $3.84 and $3.97 per share. This highly stable company with a good yield should be considered as a core holding for income investors.
