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Could Realty Income Corporation Be a Millionaire-Maker Stock?

One of the tried and true ways to build wealth is by owning investment properties, but it requires a lot of time and effort, and a fair amount of leverage. Being a landlord is not for everyone, which is why real estate investment trusts, or REITs, are such an enticing investment option. They allow you to be a landlord without all the work. Realty Income Corporation (NYSE: O) is an REIT industry bellwether, but is it the kind of investment that can make you a millionaire?

What it is and isn't

The first thing to understand about a company like Realty Income is the purpose of the REIT structure. Real estate investment trusts are companies that own investment properties with the goal of passing the income generated from the properties on to shareholders. The REIT structure is specifically designed for this, requiring that a company pass at least 90% of its earnings on to shareholders via dividends. Doing so allows REITs to avoid corporate level taxation, with the shareholder reporting the income as ordinary income when preparing their individual tax returns.

Three golden eggs in a net made of dollar bills
Three golden eggs in a net made of dollar bills

Image source: Getty Images.

The second thing to understand about Realty Income is its triple net lease niche. Realty Income owns single-tenant properties. Its tenants pay for most of the costs of the asset they occupy, including things like maintenance and taxes. Often Realty Income and its triple net lease peers will buy properties from a company and then instantly lease them back to the same company, allowing the tenant to free up cash for other uses. Realty Income makes the difference between the rates it gets for rent and rates it has to pay for capital (via debt and stock sales). It's a fairly stable business model since leases can last for 10 to 20 years.

The thing is, Realty Income's business model isn't meant to grow capital quickly. It's more of a slow and steady approach with a heavy focus on generating income. In fact, the company has trademarked the term "The Monthly Dividend Company." (It pays dividends monthly, in case you didn't figure that out.) Realty Income isn't really the kind of stock you look to for wealth-building. It's a company you own to generate income once you've got a fairly substantial nest egg.

A darn good REIT

While it's hard to suggest that Realty Income will be a millionaire maker, it's still a very desirable investment to keep in mind. The company's portfolio is heavily focused on retail assets, with about 80% of the REIT's rent roll coming from single-tenant retail stores. The rest comes from industrial (around 12%), office (around 4%), and agriculture (around 2%, mostly vineyards) investments. While that's more diversification than some of its peers, it's not all that diversified by broad sector.

Although retail has a huge impact on Realty Income's business, it is highly diversified within the sector. It owns over 5,500 retail properties with an average size of 12,000 square feet. No one single property has a material impact on the company's rent roll. The properties, meanwhile, are fairly easy to release if Realty Income is left with a vacant asset because they are basically just big, and usually well-located, boxes. Moreover, management's focus on low price point, non-discretionary, and service tenants has protected Realty Income from the overhyped retail apocalypse: Since 2017, roughly 43 retailers have gone bankrupt, but just 1% of Realty Income's rent has been affected.

O Chart
O Chart

O data by YCharts.

The REIT's dividend history speaks volumes about how successful management has been. The dividend has been increased every year for 26 consecutive years. The average annual increase over the past decade was 4.4%, beating the historical rate of inflation growth and, effectively, increasing the buying power of shareholder dividends over time. And, with a monthly dividend frequency, owning Realty Income is sort of like replacing your paycheck. Which is, when all is said and done, basically why investors should be looking at the stock.

One for the watchlist

The problem with Realty Income, though, is the yield, which is roughly 4.1% today. That's around twice what you'd get from an S&P 500 Index fund, but it's not particularly impressive for a REIT. Essentially, investors know just how good of a company Realty Income is and have pushed the stock price up and the yield down. To look at this a different way, the company's price to adjusted funds from operations, the measure used to track REIT performance, is around 20 times today -- that's what you'd expect from a growth stock, not an income stock. A yield between 5% and 6% would be a much more desirable entry point.

O Chart
O Chart

O data by YCharts.

Realty Income probably isn't a millionaire maker stock. It's the kind of conservative income stock you buy once you've reached that goal. Then you can just sit back and watch the dividend checks flow in each month. If that sounds like your goal, keep this well-run REIT on your watchlist for a price dip that pushes the yield up a percentage point or so. Such price drops do happen, and they are worth waiting for.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.