Realty Income (O 0.52%) is a Wall Street favorite because of its consistency and resilience over time. While today's 4.6% dividend yield isn't huge by historical standards, it is probably a fair level when you consider the size and quality of this industry-leading real estate investment trust (REIT). But there was an interesting $1 billion announcement that came along with fourth-quarter 2022 earnings that investors need to keep in the back of their minds.
Not much to complain about
Realty Income has trademarked the nickname "The Monthly Dividend Company." When a company does something like that it is making a statement, in this case that the REIT is a reliable dividend stock. (Over a quarter of a century of annual dividend increases attest to its dividend bonafides.) And 2022 financial results did not disappoint.
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To put some numbers on that, adjusted funds from operations (FFO) rose 9.2% year over year in 2022. Backing that up was the addition of 1,301 properties for a total investment cost of around $9 billion. The company's occupancy tallied up at 99%, "the highest in over 20 years." And it increased the dividend 4.7% year over year.
All in, shareholders should be quite pleased. There's a reason why Realty Income is an industry bellwether. But there was something else that came out along with earnings, a $1 billion investment (to be spread over a multi-year period) to help a private company called Plenty expand its agriculture business. In the grand scheme of things, this isn't a disproportionately large deal for Realty Income, but there's some nuances here that even investors who like the company need to keep in the back of their minds.
A unique deal
For starters, this is not the first time Realty Income has invested in agriculture. Many years ago it bought a collection of vineyards. This time around, however, what it is buying and helping to build are vertical farm assets. That's essentially an industrial property in which things like berries and leafy vegetables are grown. This is something of an emerging industry, but one with interesting long-term positives to help drive growth. Notably, vertical farming uses less land and water, has higher productivity levels than normal farming, and the technique can be used year round.
From a business perspective, there's a lot to like about Realty Income getting in on the ground floor. But there's an interesting twist here. Realty Income is buying land on which Plenty will build a vertical farm (to grow strawberries), which isn't particularly unusual. However, the REIT will provide "development funding" for what is likely to be a highly specialized asset. Assuming things go well, more vertical farm buildings will be built over time.
This basically looks like a way for Plenty to build out its business without having to take on debt. Instead, the cost to build vertical farms will be borne by Realty Income and, ultimately, paid for via lease payments spread over a long-term lease. Those payments are likely to be higher than they would be if Realty Income had just acquired fully built vertical farms.
If things go well this could be a very good arrangement for both companies. But if Plenty's business model falters, Realty Income could be left owning specialized assets for which it will have a hard time finding a new tenant. And, perhaps more important, it would likely be nearly impossible to find someone willing to pay similar rent. Indeed, why would a new tenant agree to cover the costs of an already-built asset?
The longer-term issue
Realty Income could handle the hit if the Plenty deal doesn't work out as planned. But the fact that it is willing to take on what amounts to start-up costs for a potential tenant hints at the difficulty that such a large REIT faces as it looks to support long-term growth. It wouldn't be fair to suggest that Realty Income has suddenly become a high-risk investment, but the Plenty deal, along with an earlier investment in a casino, suggests that management is increasingly willing to take on bigger investment risks.
Realty Income is still a worthwhile choice for investors, even conservative ones, looking for a reliable long-term dividend stock. But the Plenty deal is one that investors should still be watching closely.
