On Wall Street, it’s the hare that tends to get most of the attention, but it’s often the tortoise that ends up winning the race. That’s why long-term investors should avoid fads and stick to rock-solid companies that know how to execute in good markets and bad ones.
That is exactly what one particular slow and steady real estate investment trust (REIT) has done for more than a quarter of a century, and why you might want to buy this long-term winner today.
A simple portfolio
The REIT in question here is Realty Income (NYSE: O), which has trademarked the nickname “The Monthly Dividend Company.” That moniker is partly about its monthly cash dividend, and partly about reassuring investors that paying regular dividends is at the core of the company’s business model. Backing that up is a string of 613 consecutive monthly dividend payments and 111 dividend increases since its 1994 initial public offering.
Basically, Realty Income has rewarded investors with dividend hikes through market manias, like the tech bubble and the housing bubble, and the subsequent hard times, like the tech crash and the housing crisis. That provides investors something tangible to grab onto when watching Wall Street’s sometimes-shocking gyrations, which might keep you up at night if you didn’t have something else to ground you.
However, the real story here is how Realty Income has achieved this feat. The REIT uses a net lease approach, which means that it owns properties but its lessees are responsible for most of the operating costs of the assets they occupy. Further, it focuses on single-tenant properties, so there’s no need to find multiple tenants for every asset. Net lease is generally considered a fairly low-risk approach in the real estate space.
The portfolio, meanwhile, has a heavy focus on retail (roughly 84% of rents), where there are a lot of single-tenant properties. However, it also has exposure to the office (3% of rents) and industrial spaces (11.5%), with an opportunistic vineyard investment rounding things out to 100%. It’s also been reaching out toward Europe to expand its investment opportunities, with the United Kingdom making up just over 7% of rents. Investment-grade tenants make up around half of its tenant roster. All in all, Realty Income’s business approach is pretty balanced, straightforward, and perhaps even boring. Which is good.
Are things about to change?
But Realty Income just announced a major acquisition via an all-stock deal to buy peer VEREIT. This move will take Realty Income from being one of the biggest names in the net lease space to the undisputed king of this property niche. Its portfolio will expand from roughly 6,600 locations to over 10,000. Realty Income has made sizable acquisitions before, but this one is extremely large. However, it’s not a reason to fret. In fact, the purchase should make the REIT even better over the long term.
The reason is that net lease REITs basically make the difference between their financing costs and the rents they charge, given that they face very little ongoing property-level costs. Being larger generally improves access to capital, particularly for an REIT with an investment-grade balance sheet like Realty Income. Thus, Realty Income’s industry positioning will be even stronger once the deal is consummated. In fact, Realty Income expects the addition of VEREIT to be 10% accretive to adjusted funds from operations from day one.
There will be changes to the portfolio — for one thing, the REIT intends to spin off its office portfolio. Offices tend to be more expensive to operate than industrial or retail net lease assets, so this move is a long-term positive. Other than that, the portfolio will be very similar to what it is today.
That said, Realty Income will be left with a higher-cost debt, because VEREIT’s credit rating is lower. But that just means further cost savings down the road as that debt gets rolled over. And then there’s the cost saving inherent in eliminating redundant positions and being able to leverage its remaining employees over a larger portfolio.
All in all, buying VEREIT is a bit of an exciting move for this otherwise boring REIT, and it might take a little time to work through — but it really just cements Realty Income’s core slow and steady approach.
The problem is that investors are well aware of how reliable “The Monthly Dividend Company” is, and it is usually afforded a premium valuation. The current 4% yield isn’t exactly generous by historical standards, even though it is way more than you’d get from an S&P 500 Index fund. However, if slow and steady is your speed, it might just be worth paying full fare for an REIT that has proven its dividend reliability. Indeed, if you are building an income portfolio, Realty Income is a name you should probably be looking at very closely. If you have a value bias, meanwhile, it’s a name that you should keep on your wishlist just in case it goes on sale again, like it did in early 2020.
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