It's been a tough period for real estate, but that could now spell opportunity. Consider one of the sector's behemoths: Realty Income (O 1.41%). Its 5.7% or so dividend yield is near 10-year highs, suggesting this industry-leading real estate investment trust (REIT) is on sale.
That's great news for investors, because management estimates that there's still a huge opportunity for growth ahead. Here's what the opportunity looks like, and why -- despite being the net-lease REIT sector's 800 lb. gorilla -- Realty Income's future remains bright.
How big is Realty Income?
To give the naysayers their due, Realty Income is not going to be a fast-growing REIT. It hasn't been a fast-growing REIT for a long time, actually, with management focusing on a conservative approach that favors consistency over growth. Notably, the company has trademarked the nickname "The Monthly Dividend Company." While that speaks to the frequency of its dividend payment, it also puts front and center the importance of the dividend. Aggressive growth just isn't the goal here.
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That said, with a market cap of around $46 billion, it would be quite hard for Realty Income to grow as rapidly as smaller peers. To put a number on this, the next-largest competitor in the net lease niche where Realty Income plays, $12 billion market cap W.P. Carey (WPC 1.54%), is less than a third of that size. Net leases require tenants to pay most property-level operating expenses. Simply put, it takes a lot more to move the needle at Realty Income than it does at smaller peers.
Still, conservative dividend investors trying to find a high yield from a reliable industry leader will like what they find at Realty Income. Notably, the REIT carries an investment-grade-rated balance sheet, and the dividend has been increased annually for 29 consecutive years. Yes, dividend growth has only averaged around 4.3% over that nearly-three-decade span. However, that's more than enough to keep up with the historical growth rate of inflation, meaning that the buying power of Realty Income's dividend has grown over time.
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What about the opportunities ahead?
These stats speak to what has happened, not what the future holds. The risk is that Realty Income has become so large that it can't find enough new properties to buy. Management is confident that it has ample runway ahead to keep expanding its portfolio.
For starters, Realty Income is large enough to act as an industry consolidator. For example, it recently bought Spirit Realty, and just a few years before that it acquired VEREIT. You can't predict when Realty Income will buy a competitor, but it offers a non-organic growth avenue that shouldn't be ignored.
The sector where most of its peers operate is the U.S. single-tenant property retail sector. That niche of the net-lease space is roughly $1.5 trillion in size. That said, the REIT breaks out consumer-centric medical properties as its own group, which is roughly a $1.1 trillion opportunity. Most retail-focused net-lease REITs would probably invest in both, making their opportunity set about $2.6 trillion.
What's interesting about Realty Income, however, is that its business spans beyond retail to include a number of other niches. It believes there's a $2 trillion opportunity ahead in the industrial sector. That's long been a part of the REIT's business, but it has also been finding new niches, adding to its long-term growth opportunity.
For example, it believes existing data centers, which are new to the portfolio, are a $500 billion opportunity. That consists of existing data centers, a $100 billion opportunity, and new construction, which adds another $400 billion to the total. Gaming, also relatively new to the portfolio, adds another $300 billion to the U.S. opportunity set. The total U.S. addressable market opportunity tallies up to around $5.4 trillion. There's ample room for a $46 billion market cap company to grow in the United States.
But Realty Income isn't only focused on the U.S. market -- it also invests in Europe. Net leases aren't as prevalent in Europe, so there is a larger opportunity to grow. The U.K. alone is a $2.6 trillion market. The rest of Europe adds $5.9 trillion, for a total European opportunity set of around $8.5 trillion. Only one other significant U.S. peer, W.P. Carey, operates in Europe.
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Add the United States and Europe together and you come up with a total market opportunity of $13.9 trillion. That seems like more than enough room for a $46 billion market cap company to find additional properties to add to its portfolio.
Slow and steady, but nowhere near tuckered out
One of the big knocks against Realty Income is that its size is a limiting factor on growth. That's inherently true, since it requires more property acquisitions to grow a larger REIT. But that doesn't mean that Realty Income can't grow. It just means that growth will likely be slow and steady -- which is exactly how management likes to run the business. If you are a conservative income investor, Realty Income's historically attractive 5.7% dividend yield is one worth looking at today.
