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Is it Wise to Keep Realty Income (O) Stock in Your Portfolio?

It has been a rough phase for Retail REITs in the wake of dwindling mall traffic, shift of consumers toward online channels, store closures and bankruptcy of retailers. This has widely affected the price performance of several, including the likes of Kimco Realty Corp. KIM, Taubman Centers, Inc. TCO and Macerich Company MAC.

However, Realty Income Corporation 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. Its portfolio is well diversified with respect to tenant, industry, geography, and property type. In addition, besides retail properties, the company’s portfolio comprises industrial, office, as well as agricultural properties.

The company is focused on external growth through exploring accretive acquisition opportunities. In fact, solid property acquisitions volume at decent investment spreads aided its performance. During the nine-month period ended Sep 30, 2018, Realty Income invested $1.47 billion in 591 new properties and properties under development or expansion, situated in 37 states. The assets are fully leased, with a weighted average lease term of around 14.4 years and an initial average lease yield of 6.3%. The company remains confident of achieving its 2018 acquisition guidance of approximately $1.75 billion.

Furthermore, Realty Income’s solid underlying real estate quality and prudent underwriting at acquisition has helped the company maintain high occupancy levels consistently. In fact, since 1996, the company’s occupancy level has never been below 96%. Also, as of Sep 30, 2018, portfolio occupancy was 98.8%, expanding 10 basis points (bps) sequentially and 50 bps year over year. Management expects occupancy to remain in mid-98% for 2018. Additionally, its same-store rent growth depicted limited operational volatility.

The company continues to maintain a conservative capital structure. It has modest leverage, robust liquidity, and continued access to attractively priced equity and debt capital. Further, solid dividend payouts are arguably the biggest enticement for REIT shareholders, and Realty Income remains committed to that. In September 2018, the company announced a hike in its common stock monthly cash dividend, denoting the 98th dividend increase since Realty Income’s NYSE listing in 1994. Thereafter, the company has retained its dividend rate.

The company enjoys a trademark on the phrase “The Monthly Dividend Company” and the October 2018 dividend payment marked its 84 consecutive quarterly increases, as well as payment of more than $5.7 billion throughout the company’s 49-year operating history.

In three months’ time, shares of Realty Income have outperformed the industry it belongs to. This Zacks Rank #3 (Hold) company’s shares have gained 8%, while the industry has declined 14.9%.

Nonetheless, despite Realty Income’s efforts to diversify the tenant base, its tenants in the convenience stores and drug stores industry accounted for around 12.1% and 9.9% of the company’s rental revenues in third-quarter 2018. This makes the company’s results susceptible to any adverse changes in these industries. Also, the choppy environment and tenant credit issues remain concerns for the overall retail real estate industry.

Hike in interest rate is a concern for Realty Income. Essentially, rising rates imply higher borrowing cost for the company, which would affect its ability to purchase or develop real estate and lower dividend payouts as well. Moreover, amid rising rates, not only will financing costs increase, but common stock buyers will also demand a higher dividend yield and this may negatively impact the market price of the common stock.

Realty Income has a substantial exposure to single tenant assets. In fact, of the company’s 5,694 properties in the portfolio, as of Sep 30, 2018, 5,666, or 99.5%, are single-tenant properties and the remaining are multi-tenant assets. Nonetheless, 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 that property, as well as the value of the property suffers significantly.

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