Net lease real estate investment trusts (REITs) like Realty Income (NYSE: O) and National Retail Properties (NYSE: NNN) tend to be fairly stable income investments. However, there are important differences between these two industry bellwethers that you need to understand before buying either of them. There's also one similarity that is a little problematic for both.
Difference: Property portfolio
Both Realty Income and National Retail Properties focus on assets in which a single tenant leases a property and is responsible for most of that property's costs. That includes things like maintenance and taxes, leaving these net lease REITs to simply collect rent. This is a simplification of the relationship, but it provides a pretty good idea of the underpinnings of the sector.
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That said, National Retail Properties is focused entirely on owning domestic retail assets. Realty Income's portfolio is slightly more varied, with around 82% of rent from retail, 12% from industrial, 4% from office, and 2% from agriculture (vineyards). The company also recently expanded overseas, and it now gets roughly 1% to 2% of its rent from the United Kingdom. That's small, but it represents a toehold in Europe that is expected to open up a new avenue for long-term growth.
If you're looking for diversification, Realty Income easily gets the nod here. If that doesn't matter to you, then this issue is something of a wash. That's especially true since both have strong histories of maintaining relatively high occupancy rates over time.
Difference: Size and scale
Realty Income has a market cap of $23 billion compared to National Retail's far more modest $9 billion or so. That flows through to each company's portfolio, as well, with Realty Income owning nearly 6,000 properties and National Retail's portfolio sitting at roughly 3,000.
Both are substantial REITs with long histories of success behind them, so size hasn't been an impediment to either company. However, at this point, Realty Income needs to do more to move the needle on the top and bottom lines. So, it has to be more aggressive regarding acquisitions (note the European expansion effort). That probably gives a slight edge to National Retail.
One of the main reasons to own a REIT is to generate a consistent stream of income. Realty Income has increased its dividend, which is paid monthly, every year for 26 consecutive years. That's impressive, but it's actually a few years shy of National Retail's 30-year streak (of quarterly dividends). That said, both companies have clearly proven their dedication to returning value to shareholders via a growing dividend payment.
The two are very similar with regard to dividend growth, too. Over the past decade, Realty Income has increased its dividend at an annualized rate of roughly 4.5%, though that rate slowed to roughly 4% over the past year. National Retail's 10-year figure here is just under 3% annually, but it has been slightly higher over the last couple of years, hitting the 4% range. Neither of these REITs is going to blow you away with dividend growth. It is far more likely that you'll slightly outpace inflation, which maintains your buying power over time. Not a bad thing, but nothing to get excited about.
Dividend coverage is also strong for both REITs. In the most recent quarter, Realty Income had an adjusted funds from operations (AFFO) payout ratio of roughly 80%. National Retail's payout ratio was slightly better, at about 75%. However, neither is at a level that should worry investors.
Last up on the dividend is yield. Realty Income's yield is roughly 3.7%. National Retail's yield is slightly higher, at around 3.75%. That's more than you would get from owning an S&P 500 Index fund, but not exactly a huge yield. For example, Verizon and ExxonMobil yield around 4% and 5%, respectively. If you're looking to maximize the income your portfolio generates, neither of these REITs is likely to fit the bill.
The relatively low yields here lead right into valuation. Although not a normal valuation metric, dividend yield can provide some insight into this issue. Both Realty Income and National Retail have historically low yields. That suggests both are looking a bit expensive today.
Backing that up are price-to-funds-from-operations ratios that look rather high. FFO is the real estate equivalent of earnings. Realty Income's price to projected 2019 FFO is a whopping 21 or so. That's a number you would expect to see from a growth company, not a slow and steady dividend payer. National Retail Property's price to projected FFO is similarly high at roughly 20.
Neither of these REITs is particularly cheap today, but that's something of a mixed blessing. A key source of growth capital for REITs is selling new shares. You raise more money when your shares are expensive than when they are selling cheaply. (Both have been issuing shares.) So, current valuations may be a good thing for current shareholders, but a much bigger problem for those currently considering a purchase.
Great companies, not great investments
There's no question that Realty Income and National Retail Properties are well-run REITs. Their impressive dividend histories prove that out. Current shareholders should be pleased with both. That said, if you are in the market for a REIT, it's hard to justify an investment in either at their current prices. Of the two, Realty Income's diversification probably gives it an edge, but both really belong on your wish list, not your buy list.
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