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Is it Prudent to Keep Realty Income (O) in Your Portfolio Now?

Zacks Equity Research

With changing consumer preferences, right-sizing of footprints and store closures are in motion, while the ones unable to cope with competition are filing bankruptcy. These have resulted in turbulence in the retail real estate market, forcing structural changes. Even the likes of Simon Property Group, Inc. SPG, Kimco Realty Corporation KIM and Macerich Company MAC were not immune and have made aggressive attempts to adapt to the changing scenarios.

Amid these, 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’s solid underlying real estate quality and prudent underwriting at acquisition has helped maintain its high occupancy levels consistently. Since 1996, Realty Income’s 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, earlier this month, in a major move to enhance its portfolio, Realty Income agreed to acquire 454 single-tenant retail properties from CIM Real Estate Finance Trust, Inc. for around $1.25 billion in cash. The deal, expected to take place in a number of tranches with majority of the buyouts taking place this year, will be immediately accretive on a leverage-neutral basis, per management.

Specifically, Realty Income hiked its 2019 acquisition guidance, projecting it at $3.25-$3.50 billion, up from the $2.0-$2.5 billion guided earlier. Also, the company increased its adjusted funds from operations (FFO) per share outlook to $3.29-$3.34 from the prior projection of $3.28-$3.33 in order to reflect the acquisition impact.

Realty Income also 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. The company enjoys a trademark on the phrase “The Monthly Dividend Company” and has witnessed compound average annual dividend growth of around 4.6% since its listing on the NYSE.

However, despite Realty Income’s effort to diversify the tenant base, its tenants in 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 its 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. Notably, single-tenant leases involve specific and significant risks associated with tenant default. Thus, in case of financial failure 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 year-to-date period, shares of the company have outperformed the industry. While the stock has appreciated 15.2%, the industry has gained 13.5% during this period. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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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