A declining interest rate environment is generally a positive catalyst for the stock market. With lower interest rates from risk-free investments like CDs, more money rotates into riskier assets like stocks. Additionally, lower borrowing costs make people feel more comfortable spending money, leading to more economic activity.
That said, there are certain parts of the stock market that benefit more from falling interest rates than others. One in particular is real estate, and it could be a good time to shop for prime real estate stocks while the Federal Reserve is still in the early stages of its rate-cutting cycle. Real estate income (NYSE:O) is one of the best real estate investment trusts (REITs) on the market, trading at a significant discount to its peak. Here’s why this monthly dividend stock with a 5.6% yield could be smart to put on your radar as we approach the end of 2024.
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Realty Income owns approximately 15,500 properties in the United States and Europe. About 80% of rental income comes from retail tenants, but don’t let that put you off. The vast majority of the company’s retail tenants are in businesses that are recession-proof, immune to e-commerce disruption, or both.
In concrete terms, 90% of the portfolio fits into one or more of the following categories:
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Non-discretionary retailers who sell things to people needno matter what the economy does. Drugstores are a good example.
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Discount-oriented retailers sell things at prices that even online mega-retailers can’t match, and they tend to perform even better in recessions. Dollar stores are among Realty Income’s top tenants, as are warehouse clubs.
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Service-based retailers sell experiences or services instead of physical products. These businesses, such as auto repair shops and fitness centers, are not easily disrupted by e-commerce.
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Non-retail properties such as industrial, agricultural and gaming properties are obviously not susceptible to retail headwinds.
Not only are the tenants solid, but Realty Income’s tenants also sign long-term net leases with built-in rental growth and requiring tenants to pay taxes, insurance and maintenance fees. All Realty Income has to do is attract a quality tenant and enjoy reliable and growing income year after year.
Realty Income has been a publicly traded REIT for 30 years and handily has the total return of the S&P500 during the same period. Furthermore, at the time of writing, the stock has a dividend yield of 5.6% and the payout has been increased for 108 consecutive quarters.
Realty Income has underperformed the market in recent years. And while that is so some The tenant risk involved here is not the company’s main motivation. It’s interest rates.
In fact, since the beginning of 2022, the Vanguard Real Estate ETF (NYSEMKT: VNQ)which is a solid indicator for the overall real estate industry, has a negative-Total return of 7%. On the other hand, even accounting for the effects of the 2022 bear market, the S&P 500 has returned a total of 32% over the same period.
Without taking an economics lesson, REITs are very sensitive to interest rates and in particular tend to have an inverse relationship with 10-year Treasury yields. Note that the charts’ peaks and troughs occur simultaneously, such as the real estate stock trough coinciding with the 10-year Treasury bond’s peak at the end of 2023.
Now, the 10-year Treasury bond doesn’t have a perfect correlation with Federal Reserve rate cuts, but it does tend to move in the same direction. If the Fed cuts rates several more times in the coming years, as is widely expected, Realty Income could be in a prime position to deliver outperformance.
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Matt Frankel has positions in Realty Income and Vanguard Real Estate ETF. The Motley Fool holds positions in and recommends Realty Income and Vanguard Real Estate ETF. The Motley Fool has a disclosure policy.
The Fed has lowered interest rates. Here’s why this excellent high-dividend stock is a buy. was originally published by The Motley Fool
