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Here's Why You Should Hold Realty Income in Your Portfolio Now

Zacks Equity Research

The rapid shift toward e-retailing, store closures and retailer bankruptcies have emerged as pressing concerns for retail landlords, which include the likes of Macerich Company MAC, Taubman Centers, Inc. TCO and Urban Edge Properties UE.

However, Realty Income O has been able to differentiate itself by deriving more than 90% of the company’s annualized retail rental revenues from tenants with a service, non-discretionary, and/or low price point component to their business. Such businesses are less susceptible to economic recessions as well as competition from Internet retailing.

The company put up a better-than-expected performance in the second quarter, benefiting from year-over-year growth in revenues and recording modest same-store rent growth.

Notably, the company is focused on external growth through exploring accretive acquisition opportunities. In fact, solid property acquisitions volume at decent investment spreads aided the company’s performance. Realty Income invested approximately $1.1 billion in high-quality real estate during the quarter, including concluding its first-ever international real estate investment in the U.K. This brought the investment tally to more than $1.6 billion during the first half of the year. Moreover, management continues to maintain the 2019 acquisition guidance in the range of $2-$2.5 billion, backed by strength in the company’s present investment pipeline, which is encouraging.

Particularly, the second-quarter closing of the £429-million sale-leaseback transaction with Sainsbury's, which marks the company’s first international real estate acquisition, involved gaining of 12 properties in the U.K. under long-term net lease agreements with Sainsbury's. Sainsbury's is one of the top operators in the grocery industry and with this long-term investment, Realty Income is well poised to capitalize on the solid strength of the real estate fundamentals as well as the stability of the U.K. economy.

Admittedly, the company’s solid underlying real estate quality and prudent underwriting at acquisition helped maintain its high occupancy levels consistently. Since 1996, Realty Income occupancy level has never been below 96%. Additionally, as of Jun 30, 2019, portfolio occupancy was 98.3%. Management expects occupancy to be approximately 98% this year. Additionally, its same-store rent growth depicted limited operational volatility.

Moreover, Realty Income has robust liquidity, and continued access to attractively priced equity and debt capital. The company ended the second quarter with nearly full availability on its $3 billion revolving credit facility and a debt-to-EBITDA ratio of 5.4x. In addition, it has a well-laddered debt maturity schedule.

Furthermore, solid dividend payouts are arguably the biggest enticement for REIT shareholders, and Realty Income remains committed to that. In May, the company announced a hike in its common stock monthly cash dividend, marking the 102nd dividend increase since its NYSE listing in 1994. Notably, the company enjoys a trademark on the phrase “The Monthly Dividend Company” and to date, it has announced 589 consecutive common stock monthly dividends throughout its 50-year operating history. In fact, this retail REIT has generated a compound average annual dividend growth of around 4.6% since its listing on the NYSE. The company is also a member of the S&P High Yield Dividend Aristocrats® index for having increased its dividend every year for more than 20 consecutive years. Given its financial position and lower debt-to-equity ratio compared to the industry, the latest dividend rate is likely to be sustainable.

However, despite Realty Income’s effort to diversify the tenant base, its tenants in the convenience stores and drug stores industry accounted for around 11.9% and 9.3% of the company’s rental revenues for the quarter ended Jun 30, 2019. This makes the company’s results susceptible to any adverse changes in these industries. Also, the choppy environment and tenant credit issues are concerns for the retail real estate industry.

In addition, Realty Income has a substantial exposure to single tenant assets. In fact, of the company’s 5,951 properties in the portfolio, as of Jun 30, 2019, 5,922, or 99.5%, are single-tenant properties, and the remaining are multi-tenant assets. Nevertheless, single-tenant leases involve specific and significant risks associated with tenant default. Thus, in case of financial failure of, or default in payment by, a single tenant, the company’s rental revenues from the property as well as its value suffer significantly.

Realty Income currently carries a Zacks Rank #3 (Hold). In the past six months, shares of the company have outperformed the industry. While the stock has appreciated 3.1%, the industry has declined 2.2% during this period.

Note: Funds from operations (“FFO”), a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income.

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