Real estate investment trusts (REITs) are a great way for small investors to gain access to the income available from institutional-level real estate that would, otherwise, be outside of their reach. However, not all REITs are made of the same stuff.
If you are new to the REIT sector, you should probably start with a slow and steady giant. Realty Income (O -0.17%), which has trademarked the nickname "The Monthly Dividend Company," is where I would suggest you begin your REIT journey, especially today. Here's why.
Realty Income has a simple business model
Realty Income buys real estate and then leases it out to tenants. Virtually all of its properties are leased to just a single tenant. However, it is important to note that the REIT makes use of net leases, which means that its tenants are responsible for paying most property-level operating costs, like maintenance and taxes. Although any single property is a high risk, across a large portfolio this model is fairly low-risk. For example, avoiding property-level expenses reduces the impact that inflation has on the company's financial results.
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Realty Income is not the only REIT that uses the net lease approach. But it is one of the largest, with a market cap of $35 billion and a portfolio of over 13,000 properties. Roughly 75% of Realty Income's portfolio is focused on retail assets, which tend to be fairly generic and easy to buy, sell, and re-lease. However, it also provides exposure to industrial assets and niche properties like casinos and vineyards. On top of that, it has been expanding into Europe, where the net lease market is small, but growing. It is, put simply, the industry bellwether in the net lease space, a title it has earned for reasons well beyond its size and diversification.
Realty Income is boring but consistent
If you are looking at REITs, you are probably interested in income. That's one of the biggest ways in which Realty Income stands out. As noted above, the company trademarked the nickname "The Monthly Dividend Company." While that speaks to the dividend frequency, which is monthly, it really highlights the commitment management has to paying a reliable dividend. On that score, the dividend has been increased annually for 29 consecutive years. That's a very impressive streak.
There's one additional fact here that's important, however. The average annualized dividend increase over that 29-year span is 4.4%. That's a touch higher than the historical growth rate of inflation, so the buying power of the dividend has grown over time. But this story is not about dividend growth, given that 4.4% isn't exactly an eye-catching number. It is really about adding an attractive yield from a reliable dividend payer.
Realty Income is out of favor
Right now could be a good time to add Realty Income to your portfolio, too. Its dividend yield is currently around 6.2%. That's toward the high end of the REIT's yield range over the past decade. This suggests that the stock is historically cheap right now.
O Dividend Yield data by YCharts
The reason why investors are so negative at the moment is largely related to interest rates, which have been on the rise. That makes income alternatives like CDs more attractive and investors have, thus, been shifting out of income stocks, which inherently require taking on more risk. Higher interest rates also put pressure on a REIT's business, since they increase the cost of the debt that gets used to buy new properties.
However, property markets are highly likely to adjust over time, providing Realty Income with profitable investment opportunities. That's where the size factor comes back into play. Realty Income is large enough to take on deals that its peers couldn't handle, like acquiring entire portfolios all at once. That should make it an attractive partner as companies that own property consider alternatives as they deal with their upcoming debt maturities.
Get to know REITs with Realty Income
Put it all together and Realty Income is a great first investment in the REIT sector, offering yield, dividend growth, value, and a solid, if boring, business. For those worried about the dividend's safety, meanwhile, the adjusted funds from operations (FFO) -- which is like earnings for an industrial company -- payout ratio is a reasonable 76.5%. Realty Income also has an investment-grade rated balance sheet providing a rock-solid backup for the dividend.
There are REITs with higher yields, faster dividend growth rates, and more exciting business models. But if you are just starting out in the REIT sector, sticking to a reliable giant will help you get your feet wet and provide you with a solid foundation when the time comes to buy more REITs.
