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Is Realty Income a Buy?

Feb 28, 2021 by Reuben Gregg Brewer
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Realty Income (NYSE: O) is a bellwether name in the net lease real estate investment trust (REIT) niche. It has earned that level of recognition. Indeed, there are a lot of things to like about the company. But there's also something investors need to think about before jumping aboard. After all, no stock is perfect. Here's the many pros of Realty Income and one very important negative to monitor.

1. An incredible record

The first and most notable thing about Realty Income is its dividend history. First, the REIT pays monthly, so owning it is kind of like replacing a paycheck. However, the really big story is that the dividend has been increased annually for 28 consecutive years. That puts Realty Income into the elite Dividend Achievers category. You don't amass a record like that by accident; it takes a consistent and proven approach. Its dividend is, basically, proof that management knows what it's doing.

2. Sizable portfolio

Over the last 28 years, Realty Income has become a truly giant company, with a portfolio of more than 6,500 properties. Although roughly 85% of its portfolio is tied to retail assets, no single tenant accounts for more than 6% of its rent roll. And even there, the lessee (Walgreens) occupies multiple properties, so the risk from any one location is diminished.

The rest of the portfolio is largely spread between industrial and office properties, providing a little bit of diversification to the mix. However, roughly 4.5% of the top line is generated from properties in the United Kingdom. That's small, relatively speaking, but it could open up a whole new continent of opportunity for Realty Income. Indeed, given its size, branching out to Europe will help ensure it can continue to expand for years to come.

3. Surviving the storm

While Realty Income's business is clearly time tested, given the 28 years worth of annual dividend increases, it's worth noting that it hiked its dividend every quarter in 2020. They were token increases, to be sure, but the statement made was huge. Indeed, in the face of a global pandemic, Realty Income's business barely skipped a beat.

In fairness, rental collections fell into the low 80% range early in the pandemic when governments were shutting their economies to slow the spread of the novel illness. But Realty Income's collection rate quickly recovered, to around 94% or so by the end of the year. The coronavirus was something of a 100-year storm, if you will, and the fact that Realty Income took the hit and kept rewarding investors is very reassuring.

4. Low cost of capital

So far so good, but now we're at an item that's something of a mixed blessing. One of the big pluses for Realty Income is that it has a low cost of capital. That's vital in the net lease space. Effectively, Realty Income provides capital to companies by buying their property and instantly leasing it back to them, generally under long-term leases. It makes the spread between its cost of capital and the rent it collects. Realty Income's investment-grade balance sheet ensures good interest rates in the bond market and a relatively lofty stock price means cheap equity capital. Notably, the REIT's yield is toward the lower end of its historical range today -- which is the problem.

Investors know how well run Realty Income is at this point and it generally trades at a premium price compared to peers. So while its 4.6% dividend yield is generous compared to the S&P 500 Index, you can find others in the net lease space with far more generous payments. That said, Realty Income's yield is around the middle of the range over its recent history (say the past decade), so it isn't cheap, but it isn't as expensive as it has been. Value investors will probably want to keep this REIT on the wish list, but investors willing to pay a fair price for a great company should still be attracted here.

More positives than negatives

When you step back and look at Realty Income, the positives really do outweigh the negatives. In fact, the one big negative, valuation, is kind of a positive, too, given that a low cost of capital helps the REIT grow its business. All in, for conservative investors looking to add a reliable dividend payer to their portfolio, Realty Income is worth a close look. And if you can handle paying full fare to get in on a well-run company, it might even make it into your portfolio today.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.