Real estate income (NYSE:O) has long been a favorite among income-oriented investors, given its attractive yield and monthly dividend payout.
Nevertheless, the Real Estate Investment Trust (REIT) has had a tough few years, with its share price down around 20% over the past five years. However, the company has just raised its guidance for the year, perhaps indicating that better days are ahead.
Let’s take a look at why the stock has been struggling, and whether the higher forecast could be a sign of better days ahead for the REIT.
Recent struggles
Many of the problems with Realty Income stock in recent years have been related to rising interest rates. The REIT owns a portfolio of largely detached properties that are leased by recession-proof and e-commerce retailers such as supermarkets and pharmacies. It has also expanded into industrial and gambling properties.
It also uses long-term triple net leases, where tenants are responsible for utilities, property taxes and maintenance. This reduces the REIT’s exposure to unexpected cost increases.
While its business model is solid, the underlying value of its properties has fallen as interest rates have risen in recent years. That’s because commercial real estate is generally valued based on capitalization rates (cap), which is a property’s net operating income divided by its current value. Now that interest rates have risen, so has the cap rate.
Capitalization rates are like the opposite of a price-to-sales or price-to-earnings ratio: the lower the number, the more expensive the property. Capitalization rates increase when 1) the income from a property increases or 2) the value of the property decreases. In higher interest rate environments, property values ​​typically decline due to higher debt burdens. Therefore higher ceiling rates.
While Realty Income hasn’t faced too many operational issues, its properties purchased at lower interest rates have lost value, which has impacted its stock price. The good news, however, is that the rate hikes appear to be over, which should stabilize cap rates. In the meantime, if the Fed starts cutting rates, cap rates could go down and real estate values ​​could rise.
Increased prediction
From a property valuation perspective, the worst is likely behind Realty Income in this current interest rate environment. Meanwhile, the company continues to invest in new properties at higher cap rates.
As part of the announcement to raise the lower end of its guidance, the REIT said it now plans to invest $3 billion in new properties, up from a previous expectation of $2 billion. The company cited an improved investment climate, particularly in Europe, as a reason for raising its prospects. In the first quarter, the company saw better investment results in Europe, with an initial weighted average cash return of 8.2% versus 7.8% overall.
Looking ahead, the company has increased its forecast for adjusted funds from operations (AFFO) to a range of $4.15 to $4.21 per share, compared to prior expectations of $4.13 to $4.21 per share. The REIT continues to expect same-store rents to increase by approximately 1% and occupancy rates to exceed 98%. It said it sees a continued stable outlook for its business overall.
Is it time to buy the shares?
With Realty Income’s AFFO expected to be around $4.20 based on company guidance and a dividend payout of around $3.15, the dividend is well covered and has room to grow. Meanwhile, cap rates appear to have stabilized and could fall if the Fed cuts rates in the coming years, which would be good for Realty Income’s property values ​​and therefore the stock.
Operationally, Realty Income’s business looks fairly stable, despite some potential customer bankruptcy issues with Red Lobster, which represents 1.1% of contracted rent. The increased guidance speaks to how the company is addressing these issues and how its overall portfolio is performing.
All things considered, now seems like a golden opportunity to buy the stock ahead of what should be a nice turnaround over the next few years as interest rates and cap rates decline.
Should you invest €1,000 in real estate income now?
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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 has a disclosure policy.
Real estate income has just strengthened guidance. Is this a golden opportunity to buy these 6% yielding shares? was originally published by The Motley Fool
