HomeBusiness3 Reasons to Buy Real Estate Income Stocks Like There's No Tomorrow

3 Reasons to Buy Real Estate Income Stocks Like There’s No Tomorrow

Real estate income (NYSE:O) has long been an investor favorite on the income front, given its monthly dividend payout increases quite regularly. However, the share price performance has been quite disappointing over the past five years, falling by more than 15% over that period.

More recently, however, Realty Income shares have started to regain some momentum, and are up more than 25% over the past year. With this momentum likely to continue, let’s look at three reasons why you should choose this name.

1. Realty Income offers a stable and increasing dividend

When it comes to paying higher dividends annually, Realty Income is a star performer. The Real Estate Investment Trust (REIT) has increased its dividend for 29 years in a row and seen 108 consecutive quarterly increases.

Over the past ten years, the dividend has had a compound annual growth rate of 4.3%, from $0.90 per share in 2014 to an annual run rate of $3.156 as of the end of July. The current monthly dividend was just increased in October to $0.2635 per share, good for a forward yield of about 5.1%.

The ability to consistently increase the dividend comes from its stable, predictable business model. How a REIT like Realty Income makes money depends on the difference between the rental income it generates from the properties it owns and the interest expense to finance those properties. It uses so-called triple net leases, where tenants are responsible for utilities, property taxes and maintenance (in addition to rent).

The triple net leases allow Realty Income to avoid unexpected cost increases, while tenants typically enter into long-term leases with an initial term of 10 to 20 years and annual rent escalators. This, along with acquiring new properties, provides a nice steady and increasing increase in adjusted funds from operations (AFFO), which it then uses to increase its dividend.

See also  This is where Super Micro Computer is going in 2025

2. Realty Income’s portfolio has increased diversity

Traditionally, Realty Income has focused on the retail sector, preferring to rent to what it considers less economically sensitive retailers, such as supermarkets, dollar stores and pharmacies, which are better insulated from the pressures of e-commerce. However, the REIT has diversified its operations in recent years.

First, it expanded into Europe, where it now has a real estate portfolio of about $11 billion. Recently, this has been the company’s largest area of ​​new investment, where it has been able to obtain higher capitalization rates (caps) than in the US. Cap rates are essentially the return on a lease, which is calculated based on a property’s net operating income and divided by its purchase price.

Meanwhile, the company has increased its exposure to industrial properties with the acquisition of Spirit Realty earlier this year. These properties now account for approximately 14.5% of annual contractual rent.

Realty Income has also begun investing in other industries, such as casinos and data centers. It entered the gambling industry in 2022 with a $1.7 billion sale-leaseback deal with the Encore Boston Harbor Casino, and later purchased a nearly 22% equity stake in the ownership of The Bellagio Las Vegas, managed by MGM Resorts.

Last year, the company invested approximately $200 million to acquire an 80% equity stake in two data centers being built by Digital real estateforming a joint venture with the data center REIT.

This diversification comes at a good time as pharmacies and dollar stores have come under pressure, as have home furnishings and home decor stores. Shore vegetables is one of Realty Income’s largest tenants, and the pharmacy chain plans to close about 25% of its locations. However, the REIT said only 26 basis points of its total portfolio of annualized contractual rents expires at Walgreens over the next 2.5 years.

See also  Warren Buffett's Berkshire Hathaway raised cash, sold shares and halted buybacks ahead of the election

On the last earnings call, the REIT’s management said it was addressing rental risks associated with Rite Aid, Red Lobster, Walgreens, Dollar treeHome, and Big Lot until the end of 2026 amounted to only 2.3% of the total portfolio on an annual basis of contractual rent.

Management said that if it can achieve the 84% average recovery rate normally achieved in bankruptcies over the long term, the potential risk for its AFFO is just $0.02 per share. Meanwhile, the company said any advance notice of store closures provides value because it typically gives the company years to plan for optimal results.

New shopping complex.

Image source: Getty Images.

3. Lower interest rates will help real estate income

Realty Income’s lackluster stock performance in recent years has been largely the result of higher interest rates. Commercial real estate is generally valued based on the aforementioned maximum rates, which are heavily influenced by interest rates. As the cap rate follows rising rates, the value of properties purchased at a lower cap rate falls to reflect the current higher cap rate.

For example, if a REIT purchases a commercial property for $5 million at a 4% cap interest rate, it would generate $200,000 in net operating income per year at the start of the lease. If the rental escalators pushed net operating income to $220,000 after five years, but the cap interest rate increased to 6%, the REIT would generate more income, but the current value of the property would now be closer to $3.7 million ($220,000 operating). income/cap rate of 6% = property value of $3.67 million). Since the Fed raised rates earlier, this is why Realty Income stock struggled.

See also  Jensen Huang just delivered some incredible news for Nvidia stock investors

However, the Fed recently cut rates by 50 basis points, which is expected to be the start of a rate cut in the coming years. Meanwhile, cap rates have also started to fall in the US and Europe, after a steady increase since early 2022. If this is the start of a trend, Realty Income should see the value of its real estate portfolio rise. and therefore also the stock.

Time to Buy Realty Income Stock?

While Realty Income has some tenant headwinds, they appear to be very manageable, and the company has a long history of dealing with stressed tenants and recapturing rents. More importantly, the REIT market appears to be at the beginning of a cycle of lower cap rates, which will help reverse some of the diminished value the company has seen in recent years. As such, I would be a buyer of the stock as it looks poised to be a big rate cut winner.

Should you invest €1,000 in real estate income now?

Consider the following before purchasing shares in Realty Income:

The Motley Fool stock advisor The analyst team has just identified what they think is the 10 best stocks for investors to buy now… and Realty Income wasn’t one of them. The ten stocks that survived the cut could deliver monster returns in the coming years.

Think about when Nvidia created this list on April 15, 2005… if you had $1,000 invested at the time of our recommendation, you would have $765,523!*

Stock Advisor provides investors with an easy-to-follow blueprint for success, including portfolio building guidance, regular analyst updates, and two new stock picks per month. The Stock Advisor is on duty more than quadrupled the return of the S&P 500 since 2002*.

View the 10 stocks »

*Stock Advisor returns September 30, 2024

Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool holds and recommends Digital Realty Trust and Realty Income. The Motley Fool has a disclosure policy.

3 Reasons to Buy Real Estate Income Stocks Like There’s No Tomorrow was originally published by The Motley Fool

- Advertisement -
RELATED ARTICLES

LEAVE A REPLY

Please enter your comment!
Please enter your name here

Most Popular

Recent Comments