Over the past month or so, shares of Realty Income Corp. (NYSE:O), as well as those of many similar REITs, have dropped by more than 8%. When a great dividend stock like Realty Income drops so quickly, it's important to determine whether there is a good reason for the lower price, or if this is a buying opportunity brought on by sector weakness or another factor that has little to do with its long-term outlook.
So why did Realty Income's share price fall, and is now a good time to get in?
Possible reasons for the drop
There are a few possible explanations, but I think it mainly involves interest rate risk.
Over the past month or so, with the markets rising, there has been renewed speculation that the Federal Reserve will indeed begin to raise interest rates later this year. Since Realty Income borrows money to fund its purchases, any increase in short-term rates would raise its cost of borrowing money, therefore eroding the profit margin between its costs and the money its properties can produce.
Another simple but valid explanation is that the share price was getting too high and this is simply a correction. As my colleague Jordan Wathen pointed out (almost exactly at Realty Income's highs, I might add), at about 20 times funds from operations, the stock looked a little pricey from a valuation standpoint.
Why Realty Income?
Simply put, it's tough to make the case that any other dividend stock has a better risk/reward ratio than Realty Income.
The company owns about 4,300 commercial (mostly retail) properties that have maintained an exceptionally strong occupancy rate, no matter what the economy has done. In fact, Realty Income's occupancy rate has never dipped below 96.6% (it's at 98.4% now).
Plus, the very nature of the business creates a much more consistent and predictable income stream than most other forms of real estate. Commercial tenants sign "net leases," under which they pay most of the variable expenses associated with property ownership, such as taxes, insurance, and maintenance costs. The leases themselves are also much longer than those of, say, residential properties, with an average lease term of 15 years or more, which typically incorporates annual increases. All Realty Income has to do is collect a check.
To create growth, Realty Income actively looks for opportunities to expand its portfolio through acquisitions. The company made $1.4 billion in acquisitions in 2014, and plans to add between $700 million and $1 billion in new properties during 2015.
In addition, the company's dividend record is excellent. In fact, Realty Income was recently added to a Dividend Aristocrats index after its 20th consecutive year of payout increases. Including dividends, Realty Income has averaged total returns of more than 17% annually over its 20-year history as a public company. Maintaining that kind of performance for such a long time period is extremely rare and impressive, especially for a relatively low-risk business model.
It's never a bad time to buy
While I think the Federal Reserve will raise interest rates this year, I don't think the impact on Realty Income will be significant. After all, of the company's $5.4 billion in total liabilities, less than 8% is in the form of variable rate debt.
Of course, if interest rates do rise, Realty Income's share price could fall further. However, with such a stock, you need a long-term mentality. In other words, while it's nice to buy shares a little cheaper, the impact to your long-term performance won't be too significant. So, if you like Realty Income over the long run (as I do), look at the recent price dip as a way to get in a little cheaper. Then, if the price falls even more, buy a little more.
The point is that there's never really a "bad" time to buy Realty Income. As long as you approach the investment from a buy-and-hold perspective, you should do well for years to come.