Realty Income (O -0.17%) has increased its dividend annually for 29 consecutive years. The current yield is around 5.8%, which is significantly more than you could get from an S&P 500 index fund and above the 4.1% on offer from the average real estate investment trust (REIT) (using Vanguard Real Estate Index ETF (VNQ 0.05%) as a proxy). And yet the stock is down 20% over the past year, offering investors an opportunity to jump aboard this strong dividend payer.
Realty Income's bad news
It is important to understand what's going on with Realty Income that has investors worried. There are really two big points. First, the rapid rise in interest rates used to combat inflation has had a material impact on the REIT's business. That's not unique to Realty Income; every company that makes use of leverage is basically facing the same headwind.
As a REIT, Realty Income passes most of its cash flow on to shareholders as dividends. That means that it has to tap the capital markets, with equity and debt sales, to raise the capital it uses to buy new properties. Higher interest rates means higher operating costs. Eventually the property markets adjust, usually by lowering property prices, but that can take a little time to happen. The property market is still in the adjustment phase.
The second headwind for Realty Income is really a function of its success. With a market cap of $45 billion, it is the largest net lease REIT by a wide margin. Being so large makes it harder to expand because it requires more investment activity. The best that investors can really hope for here is slow-and-steady growth. That will make smaller, more growth-oriented peers more attractive to some investors.
Realty Income is a foundational stock holding
That backdrop, however, doesn't make Realty Income a bad investment. It just means that you need to understand what you are buying. Recently released full-year 2023 earnings highlight just how well run the REIT happens to be -- and why investors looking to maximize their dividend income might want to buy the stock even though Wall Street is downbeat on the shares. In fact, negative investor sentiment is actually a good reason to consider adding Realty Income to your portfolio today.
Despite the interest rate headwinds, Realty Income managed to boost adjusted funds from operations (FFO) in 2023. The increase was small, with the figure rising from $3.92 per share in 2022 to $4.00 in 2023, but the trajectory was more important than the amount given the difficult business environment. The dividend was also raised by a modest amount. And the adjusted FFO payout ratio was a reasonable 76% for the year. This is not a company struggling to survive, just one that is doing an admirable job navigating a hard time for the industry in which it operates.
The more important takeaway from the quarterly earnings release is probably what Realty Income is doing with its business. For example, it just completed the acquisition of a peer, which should help cement its growth expectations for 2024. It inked a deal to invest in a new property segment -- data centers -- thereby expanding the number of levers it has for future development. And it entered a trio of new European markets, building out a key platform for long-term growth. Realty Income isn't sitting still hoping for the best; it is actively working to ensure it has the best possible foundation for further expansion.
Opportunity is still knocking
Realty Income's stock is still down around 33% from where it was prior to the uptick in interest rates. The shares rallied when Wall Street thought the Federal Reserve would start cutting rates, but they have again turned lower now that this expectation seems unlikely to be fulfilled anytime soon. This is a second chance for long-term investors to jump aboard an industry-leading REIT. Realty Income won't excite you, but it can provide you with a reliable foundation for a diversified income portfolio. Don't let this second bite at the apple slip by you without at least taking a closer look at the stock.
