One of the most lucrative sources of dividend income is real estate investment trusts (REIT). Realty Income (O +0.87%) is a retail REIT that leases space to brick-and-mortar stores.
The company has a generous history of raising its dividend -- certainly a nice characteristic for anyone looking for passive income. However, one of Realty Income's largest customers appears to be in some trouble.
Dollar Tree is Realty Income's third-largest tenant, and the cost-conscious retailer announced last week that it plans to close 1,000 locations. Not only could this spell trouble for Realty Income, but should investors be worried about the sustainability of its dividend?
Let's dig into the full details and assess what's going on.
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Key Data Points
What's happening at Dollar Tree?
Dollar Tree is a discount retailer known for selling basic items from home goods, school supplies, candy, and more. In addition to its namesake locations, the company also operates a fleet of stores under the Family Dollar moniker.
During its fourth-quarter earnings, management announced that 1,000 stores will be closing. On the surface, this looks like pretty bad news for Realty Income. But as the old adage goes, there are three sides to every story. Before hitting the panic button, let's dig into how this scenario really impacts Realty Income.
Image source: Getty Images.
How does this impact Realty Income?
As of Dec. 31, Family Dollar and Dollar Tree represented 3.3% of Realty Income's total annualized-contractual rent.
Per Realty Income's investor presentation, the company leases 1,229 locations to Family Dollar and Dollar Tree. While this might seem like a lot, it actually represents less than 10% of the dollar store's total store count. That's right -- Dollar Tree and Family Dollar have more than 16,000 locations combined.
This dynamic should ease some investor panic as it's clear that Realty Income is just a small fraction of Dollar Tree's overall retail footprint.
Should investors be worried?
In addition to the details explored above, there is one more important nuance as it relates to the store closures. Dollar Tree will be conducting these closures over a multiyear period and will wait for the lease terms to expire for all the identified locations.
This means that even if some of Realty Income's locations are at risk of closure, Dollar Tree will at least continue to pay rent until the lease is up. Not only does this provide Realty Income with some level of predictable income, but it also provides the company time to seek new tenants.
Moreover, Realty Income's recent acquisition of Spirit Realty now looks even savvier in retrospect. The deal broadens Realty Income's reach by opening it up to additional end-markets. The new revenue streams from the acquired properties can help mitigate any losses Realty Income potentially experiences as a result of the Dollar Tree closures.
The last important detail to point out is that Realty Income announced yet another monthly-dividend increase. On the same day the Dollar Tree news broke, Realty Income declared its 645th consecutive monthly-dividend raise since the company's inception.
I would not worry if I was a Realty Income investor. Candidly, store closures are an inherent risk of any retail-related investment. With a long-term occupancy rate of 98.2%, Realty Income has proven that it can keep its properties filled.
I see the Dollar Tree news as more of an attention-grabbing headline than an inherent risk to Realty Income's future. With such a long history of dividend raises, I think now is as good a time as ever to scoop up shares in Realty Income for passive income investors.
