Realty Income (O) is a giant in the net lease segment of the real estate investment trust (REIT) sector. It is so large that generating additional growth requires massive investments in new assets each year. But this challenge isn't dissuading management; it has made several key moves to ensure that the REIT can continue to grow in the future. The most recent strategic push is only just getting underway. Here's what you need to know about it now.
Realty Income is the 800-pound gorilla of net lease
Realty Income has a market cap of roughly $50 billion. The next closest net lease peer, W.P. Carey (WPC 0.73%), has a market cap of around $12.5 billion. Roughly speaking, Realty Income is 4 times the size of its next closest competitor. The difference is even larger when you look at portfolio size, with Realty Income's portfolio containing more than 15,400 properties and W.P. Carey's just 1,400 or so.
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The market cap comparison is a cleaner one, since the portfolios of these two net lease real estate investment trusts are very different. A net lease requires the tenant to pay for most property-level operating costs. Realty Income generates around 72% of its rents from retail assets, which tend to be smaller properties, while W.P. Carey only gets around 22% of its rents from this property type. Meanwhile, W.P. Carey's rents largely come from industrial assets (64% of the total), which tend to be larger properties. Realty Income's industrial assets only make up around 17% of rents. Still, it is quite clear that Realty Income is a much larger entity.
Size brings advantages, most notably when it comes to tapping capital markets. Add in an investment grade-rated balance sheet, and Realty Income generally has a lower cost of capital than its peers. That allows it to compete aggressively for new investments. Meanwhile, it is top of the list when sellers are looking for a buyer, since its size means it has a voracious appetite for acquisitions.
The problem with being large, and the solution
That last point brings up a notable problem that comes along with being so large. It requires a lot of investment to keep growing. In 2024 Realty Income's investment target was $3.5 billion. W.P. Carey's target is less than half that at around $1.5 billion. The increased need for acquisitions is why Realty Income has expanded into Europe in recent years and why it has added new investment areas like casinos and data centers.
It is attempting to add more levers for growth because it needs more levers for growth. The most recent effort on this front is to start building an asset management business. The approach the company is taking is to have an open-ended structure whereby institutional-level investors can use Realty Income to manage their net lease investments. Realty Income will collect ongoing fees. This is roughly similar to what Prologis (PLD -1.28%) does in the industrial sector, so it isn't a particularly unique effort.
However, by creating this new growth lever, Realty Income gets more access to capital and it can invest in assets that wouldn't fit well in the REIT's owned portfolio. There are potential conflicts, given that there are assets that will likely be a good fit for both the owned portfolio and the still-to-be-created managed portfolio. So this is something that investors will want to monitor. However, given the successful integration of an asset management business at over $100 billion market cap industrial giant Prologis, it appears like a logical next step for net lease giant Realty Income.
Realty Income is preparing for a larger future
The real benefit here is that Realty Income can leverage its expertise and industry position in the net lease sector with little extra expense or effort by starting to manage assets for institutional investors. The fees, which are expected to be stable and consistent over time, will flow through as additional revenue to support shareholder dividends.
All in, investors should be pleased that Realty Income is proactively building this business. That said, Realty Income isn't yet running an asset management business, so shareholders need to keep an eye on its development. And, at least for a few years, should keep an eye on the progress it makes after this new growth vertical is up and running. Realty Income has a great operating history, but this is a change that should be watched closely because it is different from what Realty Income currently does.
