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Is Realty Income REIT a Buy?

May 22, 2020 by Matthew DiLallo
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Realty Income (NYSE: O) is among the more popular real estate investment trusts (REITs). That's because it's one of the few companies that pays a monthly dividend instead of the traditional quarterly installments. Those more frequent payments provide investors with an income stream that better lines up with their recurring expenses.

Given its popularity, Realty Income's yield hasn't always been as high as other REITs because investors had been willing to pay a premium for its stock. However, because of the COVID-19 outbreak, shares tumbled about 30% this year, pushing the REIT's dividend yield up to 5.3%. That discounted value, which comes with the benefit of a higher yield, likely has investors wondering if this monthly dividend stock is a good buy right now. Here's a look at the pros and cons of buying this REIT.

The case for buying Realty Income

Realty Income has treated dividend investors like royalty over the years. The REIT has paid a dividend for nearly 600 straight months. Further, it has increased its payout for the past 90 consecutive quarters and 106 times overall, growing it at a 4.5% compound annualized rate since its initial public offering in 1994.

The REIT has delivered such excellent results because it focuses on owning a diversified portfolio of stable net lease real estate. It currently has more than 6,250 commercial properties leased to over 630 tenants (48% of which have investment-grade credit) across 51 industries, though the bulk of its rent (84%) comes from retail properties.

The company backs this stable real estate portfolio with a strong balance sheet, which includes a low leverage ratio and one of the highest credit ratings in the REIT sector. That provides it with the financial flexibility to make acquisitions to grow its portfolio, earnings, and dividend.

Realty Income estimates its potential growth opportunity set at $12 trillion, which is the value of the company-owned real estate in the U.S. and Europe that it could acquire. That provides it with an enormous pool of options, increasing the probability that it will find transactions that meet its strict criteria to continue creating shareholder value.

The case against buying Realty Income

While Realty Income has done an excellent job of delivering value-enhancing growth over the years, there are some concerns about what lies ahead. The REIT's shares have sold off this year because the COVID-19 outbreak has forced many nonessential businesses in the U.S. to temporarily close their doors to help stop the spread. Because of that, many aren't paying rent.

Realty Income isn't immune to this issue, given its focus on owning retail properties. The company reported that it only collected 82.9% of the rent it billed in April. While that was much better than many other retail-focused REITs, it is a concern since continued collection delays would impact its cash flow.

That could affect Realty Income's ability to maintain its dividend because it pays out an above-average percentage of its funds from operations (FFO). In 2019, its dividend payout ratio was 81.2%. That percentage could rise in 2020 because of the COVID-19 outbreak. The company already withdrew its guidance since it's not clear how much rent it will be able to collect. If several tenants continue holding back rent, the company might need to join other REITs by reducing or suspending its dividend until market conditions improve.

The scale tilts toward buy

As Realty Income's history shows, it has been able to maintain its dividend and continue growing it in good and bad times. That's because it owns a diversified portfolio of stable commercial real estate and has a top-notch balance sheet. That portfolio has performed better than most others owned by its retail-focused peers so far during this downturn.

Add that to its financial flexibility, and it should be able to continue paying its dividend even if market conditions remain weak for a few more quarters. Because of that, Realty Income looks like a good buy right now, especially since investors can purchase shares for a lower price and higher yield.

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Matthew DiLallo 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.