Note: This is the first article of a five-part series on Realty Income Corporation.
Realty Income Corporation (NYSE: O) is a favorite stock holding of many investors, and it is easy to see why: The company's commitment to its shareholders is unmatched. Branding itself "The Monthly Dividend Company," Realty Income has an unbroken streak of 541 monthly dividend payouts and 71 consecutive quarterly dividend raises. This shareholder focus in the form of monthly dividends benefits both those looking to grow capital and those who need income in retirement.
Of course, Realty Income is not the only REIT out there. There are many others with juicy dividend yields and long histories of profitable business. Let's look at what the company does and see how it sets itself apart from competitors.
Realty Income's business
Simply put, Realty Income is structured as a real estate investment trust that acts as a landlord for businesses. They purchase commercial real estate to lease to tenants under long-term agreements of ten to twenty years. The stability that this business model affords is what allows the predictable cash flow to fund the monthly dividend expenditures.
Risk is further diminished by geographic and tenant diversification. If you lease out all of your buildings to potato distribution companies in Idaho and a great potato famine strikes, you'll soon find your stable cash flows have gone to pot. Realty Income diversifies its risk by focusing on strong companies in secure industries such as Walgreens, FedEx, and Dollar General. By its own count, the company owns 4,400 properties rented out to 235 different commercial tenants in 49 different states. Having different businesses as tenants in different states is a big reason why Realty Income's tenant occupancy has never fallen below 96%, and currently stands at over 98% as of June 30, 2015.
Tenant occupancy is a huge contributing factor to the most important metric when evaluating a REIT: adjusted funds from operations, or AFFO. Since REITs pay out 90% of their net income to shareholders, it is very important that AFFO can cover dividends and any other debt the company has to pay. A growing AFFO therefore suggests a growing dividend. Realty Income currently can cover its interest payments from its cash flow 4 times, and is projecting a 4.7%-6.2% increase in AFFO in 2015 compared to 2014. Realty Income is able to increase cash flows by steadily acquiring more properties, raising rent (projected to raise rent by 1.4% this year), and increasing occupancy. As long as they continue on this path, their dividend theoretically could be raised forever.
Personal experience affirms that a landlord of a rented property is still on the hook for a lot of costs. When the A/C goes out, the landlord has to pay for it to be fixed. Roofs need replacing, Uncle Sam needs his cut every year, and the property must be insured against catastrophes like tornadoes, hurricanes, and zombie apocalypses. These costs would be quite the administrative headache, not to mention a continual drain on resources. Realty Income is able to avoid these negatives by operating under the triple-net lease model, whereby the tenant agrees to cover all operating expenses, including taxes, maintenance, and insurance. Realty Income can sit back and collect the monthly payment which rises every year.
Realty Income versus competitors
The commercial real estate market is a large and fragmented one, which gives a company like Realty Income a distinct advantage against its competition: Retail companies are more likely to lease space from a company with a long-standing and widespread reputation . Realty Income has built this reputation, as it built its portfolio of properties, slowly and carefully. In its most recent investor presentation, the company succinctly explained this, stating that "[our] proven reputation provides competitive edge in industry." This was the only reference to competition that Realty Income made, and it shows how reputation is paramount in its business. This sterling reputation has allowed the company to keep occupancy rates high, providing for the flexibility for Realty Income to expand by acquiring more properties. A well-run business begets more business.
There are certainly notable competitors in the retail leasing industry, but none have the blend of portfolio breadth, disciplined management, and staunch dividend that Realty income offers. Such companies include W.P.Carey, which has a similar business model and higher yield but only a quarter of the properties; Lexington Realty Trust tries to claim a similar dividend history (since 1993) but cut the dividend in 2008; and VEREIT, which has a similar portfolio in size, but recently changed its name after a huge accounting scandal.
These shortcomings of these companies show the edge that Realty Income has within the industry. It has built its portfolio of companies slowly, from 630 properties in 1994 to the more than 4,400 properties owned today. Through it all, they have been transparent with their shareholders, and clearly focused on them above all else. This has lead to their inclusion into the S&P 500, as well as its status as a Dividend Aristocrat, or company with 20 or more years of rising dividends.
The only competitor that approaches Realty Income's breadth, management discipline, and dividend history is National Retail Properties. Although their real estate portfolio is only half the size of O's, this would be a competitor to certainly keep an eye on and research further.
Realty Income is the complete package, compared against its peers. One need not look further than the numbers:
|Realty Income||W.P. Carey||Lexington Realty||VEREIT||National Retail|
|Projected 2015 AFFO growth (low-end)||+4.7%||-1%||-8.1%||-11%||+4%|
|Dividend Streak (years)||21||17||5||0||25|
*Vereit plans to reinstitute dividend starting next quarter
It is telling that AFFO growth is affirmed by Realty Income and National Retail Properties, while the other three companies are warning of a possible contraction for 2015. Realty Income simply checks all the boxes.
Is Realty Income a diamond of a REIT?
The REIT field has many participants. For those investors with a long-term view, Realty Income fits perfectly. The company has built a moat of reputation, portfolio diversification, and shareholder returns that it can continue to build on forever. It isn't easy to find a company with this special blend of stability and return across any industry, and its place atop the REIT industry is unparalleled. So long as Realty Income continues to grow its adjusted funds from operations and maintains its business model, it checks all the boxes for a good long-term investment within the REIT industry.