Real estate income (NYSE:O) has long been a favorite among income-oriented investors, given its monthly dividend payout, robust yield, and history of increasing the dividend. Meanwhile, the Real Estate Investment Trust (REIT) has delivered stable, consistent results over the years.
However, now that a number of tenants are under pressure and shops have to close, the question arises: will problems arise?
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Let’s take a closer look at Realty Income’s most recent quarterly report, the safety of its dividend, and how the REIT plans to deal with some struggling tenants.
Realty Income had another steady quarter, although investor attention was certainly focused on what’s going on with pharmacy, convenience and dollar store customers. All three concepts are under pressure, with companies facing credit pressure and closing stores.
Realty Income Management pointed to tenants who have recently gone bankrupt and how they have achieved high repurchase rates. As for Red Lobster restaurants, it said it had 216 assets, nine of which were dismissed by the bankruptcy court, achieving a 91% recapture rate. That’s what it said Ritual aidwhich recently emerged from bankruptcy, managed to achieve a recapture rate of 88%.
Addressing Wal vegetables and the store closures, Realty Income said there have been 13 renewals this year, and all have been renewed, with a 100% readmission rate. Meanwhile, management noted that the REIT has historically had greater than 100% readmission rates for lease renewals CFS, Dollar treeand Family Dollar.
At the end of the quarter, Dollar general and Walgreens each accounted for 3.3% of total annualized rent, while Dollar Tree/Family Dollar was 3.1% and CVS was 1.2%.
Meanwhile, Realty Income said it was looking for a private equity fund to help it capitalize on the opportunities it sees in several industries, including retail, industrial, data centers and gaming. It said the fund would provide stable capital over the long term while incurring recurring management fees.
In terms of the REIT’s third-quarter results, revenue rose 28% to $1.33 billion as new properties were acquired through the acquisition of Spirit Realty in January and new investments boosted results. Same-store rental income rose 0.2% in the quarter, while occupancy stood at 98.7%. It said it had 170 lease renewals in the quarter, with a readmission rate of 105%.
Realty Income’s diversification strategy continued to pay off in the quarter, with retail same-store rental revenue down 0.3%, industrial same-store rental revenue up 1.9% and gaming revenue rose by 1.7%. Other properties, including data centers, saw same-store rental income increase 4.7%.
The REIT invested $740 million in new properties this quarter with a weighted average cash yield of 7.4%. It also sold 92 properties for $249 million in proceeds.
Adjusted funds from operations (AFFO) per share, a measure of the cash flow a REIT can generate from its operations, rose 3% to $1.05.
Realty Income raised the lower end of full-year AFFO guidance, bringing it to a range of $4.17 to $4.21, compared to prior expectations of $4.15 to $4.21. It now expects to invest $3.5 billion in new properties, up from a previous expectation of $3 billion.
Despite recent pressure on some tenants, Realty Income’s dividend appears safe and should continue to grow.
The REIT increased its dividend by 3% to $0.789 in the quarter. It has now increased its dividend for 108 quarters in a row.
The dividend was easily covered by the $1.05 worth of AFFO it produced in the quarter, good for an AFFO payout ratio of 75.1%. This robust coverage gives Realty Income plenty of room to continue increasing the dividend in the future.
Realty Income stock has both headwinds and tailwinds right now. While the REIT is confident of regaining lost rent due to store closures, the issues of Walgreens, CVS, Dollar General and Dollar Tree/Family Dollar should be monitored as these four tenants account for approximately 11% of the contracted rent on an annual basis. Obviously they won’t close all their stores, but it should be some form of headwind.
In the meantime, a lower interest rate environment should be good for stocks and their property values. Realty Income shares have struggled in recent years despite steady results, largely due to higher capitalization rates (cap rates) that are causing commercial real estate valuations to fall. However, now that the Fed has started lowering interest rates, cap rates have started to fall, causing commercial real estate values to rise.
Overall, I think the interest rate environment should be the biggest driver for stocks in the coming years, as Realty Income has proven its ability to handle customer credit issues and store closures in the past. In the meantime, it seems like the move toward private financing should be positive for the REIT, and likely for a buyer of the stock during this dip.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends Realty Income. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.
Does the outlook for dividend-favored real estate income look good, or is there trouble brewing? was originally published by The Motley Fool
