Realty Income (O 0.40%) has grown to become an industry goliath in the net-lease real estate investment trust (REIT) niche. It did this through internal investment as well as the acquisition of competitors. How it did it is significant because it changes the equation for the company and investors in material ways. For example, over the next year, it plans to invest more than twice as much in new properties as its closest peer.
But what exactly does that mean for investors? And where will this company be in a year?
Getting bigger
The simple answer to where Realty Income will be in a year is bigger. But that good news may not be as good as one might assume. This net lease REIT is already huge. For instance, its market cap is around $40 billion, while W.P. Carey (WPC 0.65%), the second-largest name in the net-lease space, sits at a $15 billion market cap. Essentially, Realty Income is over twice as large as its next-closest net lease peer. (A net lease requires tenants to pay for most of a property's operating costs.)
Image source: Getty Images.
This large size changes the way investors need to look at some things. For example, on an absolute basis, Realty Income is planning to invest over $5 billion in property acquisitions in 2023. That's a massive number when you consider that W.P. Carey is looking at roughly $2 billion in acquisitions at the midpoint of its guidance. So Realty Income will get much bigger than W.P. Carey, on an absolute basis, over the next year if it hits its goal. But that number isn't so impressive anymore when you consider the REIT's size relative to peers. A smaller W.P. Carey's plans end up being a touch more aggressive when you factor in its relative size. In fact, it makes complete sense that Realty Income would need to spend vastly more than its much smaller peers.
Then there's what the company expects with regard to its funds from operations (FFO) growth. On that front, the company is calling for 2023 adjusted FFO per share of between $3.93 and $4.03. That would be a fairly modest increase from the $3.92 per share in adjusted FFO it earned in 2022.
Why not more?
It should seem a little odd that so much capital investment would result in such a small increase in adjusted FFO. On the one hand, it just takes more to move the needle at a big company. But there are other things going on at the company and in the broader economy that will also be playing roles. A particularly important issue is interest rates.
At the start of 2022 Realty Income was able to issue debt with a maturity date of 2042 in Europe with an interest rate of 2.5%. Just six months later European debt issued with a maturity date of 2037 required an interest rate of roughly 3.4%. That's a notably higher rate for a bond with a shorter maturity (generally speaking, the longer the bond, the higher the rate investors demand). In January and April of 2023, meanwhile, Realty Income issued U.S. debt with interest rates between 4.7% and 5.05%. In other words, it is pretty clear that interest costs are going to be a headwind this year, reducing the benefit from the acquisition of new properties.
What's important to understand is that Realty Income, as a REIT, has to pay out 90% of its taxable income to investors as dividends. That leaves little behind to fund acquisitions. So if Realty Income wants to invest $5 billion in 2023 it has no choice but to tap the capital markets, via stock sales or debt issuances, for the cash. Higher rates will mean higher costs, even as the REIT grows its business.
A balancing act
Realty Income can't just stop buying new properties, given that doing so is essentially its entire business purpose. The spending it has planned will make it a bigger company in a year and, hopefully, will result in higher adjusted FFO. But investors need to go in with their eyes open, because other pieces of the growth equation are changing (such as the cost of debt financing), and that will limit the benefit of Realty Income's big spending plans.
