Realty Income (O -0.17%) owns some fine properties. And as a real estate investment trust (REIT), it's required to pay out 90% of its taxable income each year via dividends. For those looking for attractive income investments, a REIT could fit the bill. It could also serve as an inflation hedge since it owns properties that could appreciate over time.
But is Realty Income a good REIT to invest in? To answer that question, one must consider the type of properties it owns and its cash flow potential.
Strong tenants
Realty Income leases its properties to a broad selection of tenants, but most of them reside in the retail sector. Many of them sell the sorts of staples and necessities that remain in fairly steady demand even in a challenging economy. These include grocery stores, convenience stores, dollar stores, quick-service and casual dining restaurants, drug stores, and home improvement stores.
Last year, nearly 19% of its rental payments came from grocery and convenience stores. Another 7.4% came from dollar stores, 5.7% from drug stores, and about 4% each from automotive service and general merchandise stores.
Its top lessees are familiar names like Dollar General (NYSE: DG), 7-Eleven, Walgreens Boots Alliance (NASDAQ: WBA), FedEx (NYSE: FDX), and Walmart (NYSE: WMT). In fact, nearly 41% of its annual rent comes from companies with an investment-grade credit rating.
Cash flow
Realty Income has maintained high occupancy levels. It was at 99% at the end of the second quarter, in line with the previous quarter. The company was also able to get higher lease rates on renewals. Overall, the new annualized rents on renewed leases signed during the period were 3.4% higher than the previous payments.
All of that has contributed to respectable results on the cash flow front. When analyzing REITs, the adjusted funds from operations (AFFO) metric is particularly useful, as it serves as a proxy for cash flow available for distribution. And Realty Income's AFFO has been solid. In the second quarter, it was $1.00 a share, 3.1% higher than a year prior. That easily covered the period's $0.765 per share dividend.
For the year, management anticipates AFFO per share in the range of $3.96 to $4.01. That compares favorably to the annualized $3.066 per share dividend.
Frequent dividends, regular increases
If you like monthly dividends, Realty Income fits the bill. In fact, it refers to itself as "The Monthly Dividend Company."
More importantly, the board of directors has raised its dividend payouts annually for more than 25 years. And it typically increases them multiple times a year. This year's monthly dividend started at $0.2485, and next month's scheduled payment is $0.2555. When it increased its payout for July, that brought its streak of raises to 103 straight quarters.
Based on the current dividend and share price, the stock has a yield of 5.5%. That's more than triple the S&P 500's average yield of 1.6%.
However, Realty Income's stock appreciation has woefully underperformed the overall market. Over the last three years, the former has fallen by 3.5% while the latter increased by 30.6%. Thanks to high dividends, Realty Income's total return was 9.1%, but that still lagged, the S&P 500's 35.4%.
That's likely partly due to higher debt. It had $19.6 billion at the end of the second quarter, more than double the $8.8 billion as of Dec. 31, 2020. Higher leverage equates to a higher interest burden and increased financial risk.
Management has been buying and developing properties. Just this year, it bought 778 properties for $4.2 billion. That should bode well for the company's future, given the company's successful track record, however.
In the meantime, with strong cash flow driven by high occupancy rates and rental increases, Realty Income continues to reward shareholders with dividend growth. For income-oriented investors, that makes the stock a buying opportunity.
