Most Americans aren't familiar with Realty Income (O -0.17%), but nearly all of us have spent money inside one of its buildings. This real estate investment trust (REIT) leases commercial property to Walmart, Costco, Dollar General, Walgreens Boots Alliance, and Lowes.
With more than 15,000 commercial properties in its portfolio, Realty Income is the world's largest net lease REIT with publicly traded shares. Those shares have been beaten down about 12% from a peak in January, and they're down 34% from the all-time high they reached nearly four years ago.
In its depressed state, Realty Income stock offers an eyebrow-raising 5.9% dividend yield. Here's why there's a good chance that investors who buy it now will see their payouts rise steadily for many years to come.
Buy Realty Income for reliable dividend growth
Whether they offer groceries, convenience, pharmacy, or home improvement, a couple of common themes run through all of Realty Income's tenants. They're resilient to economic downturns, and the rise of e-commerce.
Realty Income's cash flows are highly predictable because lease obligations remain a top priority for Walmart even when consumer spending is down. Moreover, the REIT employs net leases that transfer all variable expenses such as taxes and maintenance to the tenant.
Realty Income makes monthly payments and raises its dividend more often than you might expect. The REIT's payout has risen every quarter since it became a publicly traded company in 1994.
Investors can reasonably expect more dividend raises in the near term even though adjusted funds from operations (FFO), a proxy for earnings used to evaluate REITs, declined 3.7% last year.
A recent acquisition is expected to reverse the direction of Realty Income's bottom line. The company expects adjusted FFO to rise 3.3% to 5.3% this year to a range between $4.13 and $4.21 per share. That's more than enough to comfortably raise a payout currently set at an annualized $3.084 per share.
Image source: Getty Images.
Why it's beaten down
The average dividend-paying stock in the S&P 500 index offers a paltry 1.4% yield at recent prices. Anytime you see a dividend stock offering a yield more than four times the market average, it means investors are nervous about the company's ability to continue raising its payout.
The market is nervous about Realty Income because it made some big acquisitions recently. It acquired VEREIT in 2021. In January, it completed a $9.3 billion acquisition of Spirit Realty. The Spirit transaction added about 2,000 properties to its portfolio and is expected to boost FFO by 2.5% in 2024.
The acquisitions improve Realty Income's already powerful size advantage but the stock market is worried about the quality of the assets it acquired. Only 19% of Spirit Realty's annual base rent comes from tenants with investment-grade credit ratings, compared to 40% for Realty Income.
Speaking with investment bank analysts concerned about deteriorating tenant quality, Realty Income explained that it's targeting deals with attractive risk-to-reward profiles. What it won't do is accept unattractive terms to appease a short list of potential tenants with top-tier credit ratings.
More above-average returns ahead
With an A3 credit rating from Moody's, Realty Income benefits from a significantly lower cost of capital relative to its smaller peers. With over 15,450 properties, few are as well positioned to consolidate the fragmented net lease industry.
In the U.S., more than a dozen publicly traded net lease REITs like Realty Income account for less than 5% of the addressable market. There's still room to grow in its domestic market but investors want to focus on this REIT's international expansion effort.
Realty Income is one of just a few publicly traded net lease REITs that operate in Europe and together, they own less than 1% of the addressable market. With a larger addressable market and fewer competitors, Europe could be a big source of growth for many years to come. Put it together, and this looks like a great stock to buy now and hold over the long run.
