Wall Street turned on Realty Income (O -0.17%) very quickly when the historically low-interest-rate environment went away. In fact, with interest rates rising at a shockingly rapid clip over the past year or two, investors seemed to be running for the hills here. The bellwether net lease real estate investment trust's (REIT's) shares fell by more than a third from their highwater mark at one point. For investors that think in decades, though, this pullback could be a buying opportunity.
A little background on Realty Income
As a REIT, Realty Income buys properties and leases them out to tenants. However, it uses a net lease model, which means its tenants pay for most property-level operating costs. The risk is that its properties are virtually all single-tenant, so each individual property comes with material risk. However, spread across a large enough portfolio, the risk is very low. Realty Income owns more than 13,000 properties. That's a huge number.
Image source: Getty Images.
It's a little difficult to compare property count between net lease REITs because some kinds of assets are simply bigger than others. So market cap is probably the best way to get a handle on Realty Income's scale. The REIT's $38 billion market cap is over three times the size of its next closest net lease peer. It's so big that it swallows smaller REITs for lunch. That's a joke, but not really.
In 2021, Realty Income bought VEREIT in a deal valued at around $11 billion. More recently, it announced plans to buy Spirit Realty (SRC) in a deal valued at roughly $9.3 billion. The Spirit transaction won't close until sometime in 2024, and it will increase the company's property count to over 15,000. This is important to understand if you're looking at Realty Income.
Buy Realty Income
Basically, this REIT is the 800-pound gorilla in the net lease sector, and size comes with important benefits. Not only can it take on massive acquisitions (entire companies, portfolio size property transactions, and large individual assets), but Realty Income also tends to have greater access to capital. The size of the company makes its stock more liquid and makes bonds more attractive to institutional investors. Add in an investment grade-rated balance sheet, and there's even more to like for bond investors. The key, however, is that being large and financially strong has historically resulted in a lower cost of capital, which gives the REIT an important edge over smaller peers.
O Dividend Yield data by YCharts
If you're looking for a net lease REIT and want to stick to the biggest and likely strongest company, Realty Income is the one to go with. But it gets better when you consider the share price decline, largely driven by external factors -- such as the rise in interest rates -- which has pushed the yield up to near decade highs at 5.7%. So this industry bellwether appears to be on sale right now.
Hold Realty Income
If you own Realty Income already, you might be wondering why rising interest rates have been such a negative. The answer is both simple and complex. Rising rates makes it more expensive for REITs to raise capital, putting pressure on the profitability of future acquisitions. And as old debt rolls over to higher interest rates, REITs will have to deal with higher interest expenses. That said, property markets generally adjust to rate changes in such a way that future investment remains attractive. That generally requires sellers to lower the prices of their assets, but such a reset will probably take some time as sellers try to cling to higher prices for as long as possible. The REIT sector is still in a transition period.
There's no particular reason to sell Realty Income because of this. As the chart shows, the broader REIT industry is down just about the same amount as Realty Income. Rising rates are an industrywide problem. Given that Realty Income remains well positioned in the industry and should easily muddle through until property prices adjust as they have in the past, it would probably be a mistake to sell now.
Sell Realty Income
For the most part, Realty Income is an attractive investment option for most investors, but particularly for those with a conservative, income-oriented focus. That said, it won't be a good choice for all investors, specifically those with a growth-oriented approach. With such a large portfolio, Realty Income has to invest huge amounts of money to grow. And even then, growth is likely to be slow and steady, not quick and exciting.
To give an example, the dividend has been increased annually for 29 consecutive years, but the annualized rate is only around 4.3% over that span. So even though the yield is historically high right now, Realty Income will never be the kind of stock a growth-minded investor will want to own.
What you do with Realty Income depends on you
Realty Income is a large and well-run REIT, with an industry-leading position in the net-lease niche. It's the kind of investment that most income investors should be able to appreciate. If you own it, you'll probably want to stick with it, and if you're looking at it, or have been considering it for a while, now could be a great time to pull the trigger. But if you want a company with material growth potential, that's just not what's on offer here no matter how low the price goes.
