Realty Income (O 0.52%) is a net lease real estate investment trust (REIT) giant, sporting a market cap of around $40 billion. At that size, the REIT's days of rapid growth are in the distant past. However, being big isn't all bad, either. In fact, over the past year, it seems to have worked out reasonably well compared to the average REIT. Here are the numbers to prove it.
What's been going on?
The past 12 months have been economically difficult, with fast-rising inflation and governments around the world fighting the price increases with swift interest rate hikes. This is not a particularly great backdrop for REITs. From a big picture perspective, these companies have to pay out 90% of their taxable income as dividends to avoid corporate level taxation, leaving little for capital investment (for example, buying new properties). Even REITs, such as Realty Income, which generate cash flow well in excess of the 90% rule usually pay it out as dividends anyway, as large dividends are expected by investors in this sector. Thus, REITs have to tap capital markets for cash by issuing stock and selling bonds. Simply put, REITs as a group are seeing costs rise in a material way.
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Adding to the headwinds when it comes to a landlord like Realty Income, some REITs are really more akin to financial partners. Net lease REITs generally buy property from a company and then lease it right back, essentially providing cash to the seller for other uses (like growth spending or debt reduction). That's a spread business, where Realty Income makes the difference between its cost of capital and the lease rates it can charge.
When interest rates go up, there's a transition period that can be tricky to navigate. Sellers often don't want to accept the lower prices that higher rates dictate are needed to make a deal financially palatable to net lease REITs.
Given this backdrop, it might not be too surprising to find that a $1,000 investment in Realty Income one year ago would only be worth around $850 today. That's not good news, of course, but don't think that finding a better option would be so easy. The average REIT -- if we use the Vanguard Real Estate Index ETF as a proxy -- has turned $1 into just $760 over the past year.
So, compared to the average REIT, Realty Income has held up fairly well. It would be hard to tell investors that it was a mistake to buy the company that has trademarked the nickname "The Monthly Dividend Company." That nickname is backed by not just a monthly dividend, but 28 years of annual dividend increases and over 100 quarterly hikes. If you are looking for a reliable dividend stock, Realty Income looks like a pretty good option. The dividend yield today is just shy of 5%, which is near the highest levels seen over the past decade, suggesting the shares are historically cheap.
You could probably find a CD that has a similar yield, but then you would have to give up the dividend growth potential that would help to offset the detrimental impact of inflation on your income stream over time. Realty Income's dividend, for reference, has increased at a 4.4% clip over the past 28 years, which is above the historical rate of inflation.
Mercurial investors
That said, Realty Income is just one of many net lease REITs you could buy. But, given its size and strong long-term performance, investors have often afforded it a premium valuation relative to its peers. For example, the second and third largest net lease REITs are W.P. Carey (WPC 0.27%) and National Retail Properties (NNN 0.44%), which offer yields of around 5.8% and just over 5.1%, respectively. So, even in a tough period, Realty Income is still trading with a lower yield.
But it has not held up as well as these peers, given that investors often jump ship from premium-priced stocks during difficult times. To highlight the difference, a $1,000 investment in W.P. Carey a year ago would be worth about $870 now, while that same amount put into National Retail would be worth $930. Clearly Realty Income is the laggard.
Yet these are much smaller REITs. W.P. Carey's market cap, at roughly $15.5 billion, is less than half that of Realty Income. National Retail is smaller still. And size does offer advantages, from diversification to scale to access to capital. The weak performance and high historical yield on offer from Realty Income might actually be a buying opportunity for long-term investors focused on owning large and reliable dividend stocks. Indeed, as it trades more in line with smaller peers, Realty Income's many advantages look more and more attractive.
Trade-offs
Investing is about making trade-offs, often between risk and reward. In the case of Realty Income, the past 12 months have been difficult for shareholders. However, the drop has not been as bad as the average REIT's and is, perhaps, making Realty Income more attractive as an investment option relative to other large net lease REITs. If you haven't been looking at this industry giant, with advantaged access to capital and a size that dwarfs its closest peers, maybe now is the time to start.
