Real estate income (NYSE:O) has done a fantastic job growing shareholder value over the years. The Real Estate Investment Trust (REIT) has delivered a compound annual total return of 14.1% since listing in 1994. The company has achieved those robust returns by growing its portfolio, cash flow and dividend payments.
The REIT has grown by investing shareholder capital in generating income net rent property. It plans to leverage that expertise by bringing in private capital in a brilliant way that could significantly grow shareholder value in the future. Here’s a look at this one smart strategy.
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Have real estate income grown into a behemoth in the REIT sector of the past half century. It is currently the seventh largest REIT in the world, with $58 billion in real estate assets in eight countries.
Despite its enormous size, it has a small share of the commercial real estate market. The U.S. commercial real estate market is worth approximately $20.7 trillion. Currently, publicly traded REITs like Realty Income only own about $1.9 trillion in real estate. This means that 90% of the market remains in private hands.
Realty Income plans to capitalize on this massive opportunity by launching a private investment fund institutional investors (i.e. pension funds, sovereign wealth funds and insurance companies). The fund will focus on U.S. net lease properties that the company will initially build out from some it currently owns. The goal is to grow the fund over time by attracting new investors and acquiring additional properties.
That third-party capital will provide Realty Income with additional financing to pursue more acquisitions. The REIT is winning more deals than it can close, leaving opportunities on the table. For example, the company secured $34 billion in potential transactions this year and closed just $2.1 billion, or 6% of its volume. It is highly selective, partly due to capital constraints.
Realty Income would earn recurring fee-based income to manage this third-party capital. That fee-related income would allow the REIT to grow its custom funds from operations (FFO) per share at a higher rate in the future because it would provide a much higher return on new investments in the fund.
For example, real estate income currently buys net rental properties at 7.5% maximum rate for real estate. It finances these deals with 35% debt and 65% equity (all from shareholders). However, if it were to make the same investment in a fund, it would only need to invest 20% of its equity, with fund investors covering the remaining equity requirement to maintain the same level of leverage. The REIT would earn a 1% annual fee for managing the third-party equity investments.
