Realty Income: Compounding The 5.97% Yield Into A Great Investment

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Economic data for March came in higher than expected, causing concerns about the Fed's restrictive stance and putting pressure on REITs.Realty Income shares have declined, presenting a buying ...

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PM Images This was not a good week for economic data as CPI came in hot for the month of March at 3.5%, which was an increase of 0.3% MoM and 0.1% above the consensus estimate. To make matters worse, The University of Michigan consumer sentiment fell to 77.9 points, which was a decline of 1.5 points MoM. This pushed bond yields to their highest point for 2024 as the 2-year reached 4.96%. Shares of Realty Income (NYSE:O) took a dive, as they fell drastically after CPI was announced, and finished the week down -2.6%. Now we have increased talks about how long the Fed will remain restrictive, and pressure is mounting for REITs among other sectors. While everyone is anxiously waiting for what Fed Chair Powell says at the upcoming FOMC conference on May 1st, I am adding to my position in Realty Income while others are panicking. I don't want to own commercial or residential real estate as an investment directly, but I love buying high-quality REITs and reinvesting the dividends. I have a long-term time horizon, and I think investors are getting another opportunity to own Realty Income close to its 52-week lows. If Realty Income continues to slide, I will just continue to buy, and I believe this is one of the best opportunities for long-term income investors to consider.   Seeking Alpha Following up on my previous article about Realty Income I've been bullish on Realty Income despite the higher for longer environment. Going into Q4 earnings, I was bullish that while rates were still above 5%, a rate cut would occur sometime in May or June. As the economic data has come in since January 3rd, when my last article was published (can be read here) shares of Realty Income have declined by -10.53% compared to the S&P 500, appreciating by 8.43%. When Realty Income's monthly dividend is accounted for, its total return since January 3rd has been -9.23%. Now that we have more economic data and the door is closed for a March rate cut, I want to follow up on my investment thesis as to why I am very bullish on Realty Income as shares continue to approach 52-week lows. As shares decline, I want to add to my position so that I can sit on my shares for an extremely long period of time and watch the powers of compounding work their magic. In this article, I am going to break down the numbers and show why price fluctuations over several years aren't as important to me as time in the investment.   Seeking Alpha Risks to my investment thesis Commercial real estate is not exactly the hottest space to invest in 2024. Inflation continues to be sticky, and the Fed shut the door on a March rate cut, which has called a cut in May or June into question. The CME Group Fed Watch Tool has updated the probabilities for a June rate cut, and the outcome is drastically different than last week. There is now a 71.7% chance that the Fed keeps rates where they are through the June meeting and a 37.2% chance that rates do not finish under 5% in 2024. Just a few days ago, I inserted a chart from what the CME Fed Watch Tool looked like for December of 2024 in an article I wrote about the Vanguard High Dividend Yield Index Fund ETF (VYM) (can be read here) and the chances that rates remained at 5% or higher to close out 2024 was 14.6%. A higher for longer rate environment is a critical risk factor for commercial real estate. While Realty Income generated $3.62 billion in EBITDA for the 2023 fiscal year and isn't directly in danger, rates cause an indirect risk factor for the commercial real estate giant. Realty Income has over 15,450 commercial properties that are leased to more than 1,300 clients. While a higher for longer environment may not be critical to Realty Income's financials at this point in time, it could have detrimental ramifications for some of its tenants. We exited an era of cheap capital, and there is a chance that the current operating environment where oil prices are higher, inflation is sticky, and the cost of capital is elevated could cause financial stress for some of Realty Income's tenants. If the Fed doesn't lower rates, there are bound to be some tenants that will have debt maturing between 2024 and 2025. If those tenants need to refinance and the cost of capital exceeds the models they built when they borrowed the debt, these companies could be faced with tough decisions, especially breaking or not renewing their leases. The tough operating environment may also cause some of their tenants to go under. For instance, AMC Theatres (AMC) represents 1.2% of Realty Income's portfolio, and when I go through AMC's financial statements, there is a lot of reason to be concerned about how it will manage to maintain its current footprint as they continue to utilize cash to offset their losses. Realty Income has been considered the gold standard in commercial real estate, as its portfolio occupancy hasn't declined under 96.6% since 2000. Today, Realty Income has a portfolio occupancy rate of 98.6% with a historical median of 98.2% compared to the S&P 500 REIT historical median being 94.2%. If Realty Income's tenants come under pressure and occupancy starts to drop by several percentage points, it will not only directly impact their financials, but also cause the bull case about Realty Income's historical occupancy levels to be called into question. This could also correlate to a narrative forming about Realty Income not having the ability to continue its quarterly dividend increases that shareholders have become accustomed to. If these narratives start to occur based on non-renewals of leases or tenants going under and Realty Income's financials or ability to provide dividend increases are called into question, then a 52-week low of $45.04 may look bullish compared to where shares could decline to. While I am very bullish on Realty Income, there are real risks to my investment thesis that are outside of Realty Income's control.   CME Group Why I want to own Realty Income over physical real estate as an investment Rather than owning properties with positive cash flow, I love generating income from a consistent stream of dividends. Owning physical real estate can be a great investment for the right person, but not for me. You always hear stories about how someone put a small amount of capital down and rented out the property, and the monthly rent is paying for the monthly overhead while putting some profit in their pockets. You rarely hear about the downsides of investing in real estate, such as when a property stays vacant and the investor needs to cover the monthly costs, dealing with bad tenants, tax assessments, and other potential hardships. In commercial real estate, many leases are favorable to the landlord as they are triple net (NNN) where the tenant is responsible for all the additional expenses, from taxes to repairs. The problem with commercial rather over residential in most cases is that the asset is more expensive, which makes the carrying costs higher, and if the tenant goes under or the property stays vacant, it can become a large drain on the investor. There are certainly great benefits if your rental properties do well, as you can pull equity out when the locations appreciate, and once you get going, it can be easy to scale. There are also tax benefits that can be recognized, but I simply don't want to deal with being a landlord. I love the idea of real estate as an investment, but I don't want to deal with tenants. The downside outweighs the upside for my situation, as I don't have the time to put into it. I am also not handy so for every little thing that goes wrong, I would need to hire a company to fix.   Realty Income This is why I want to be invested in Realty Income. I can gain exposure to an entity that owns over 15,450 locations and specializes in net leases. Since going public in 1994, Realty Income has generated a 13.9% compound annual return for shareholders while generating YoY EPS growth for 27 out of 28 years. Realty Income has declared 644 monthly dividends, and while they have increased the dividends on an annual basis, shareholders have benefited from 105 consecutive quarterly dividend increases. Realty Income has 11.4% of its portfolio anchored by a grocery store, and since 2000 their median occupancy level has been 98.2%. Today, 98.6 of their locations are filled, and the team at Realty Income has established a track record of scaling their asset base and driving larger amounts of EBITDA from its ongoing investments. As an individual, I can't compete with Realty Income, nor would I want to. I would rather invest in Realty Income for exposure to the commercial real estate market and collect a solidified monthly dividend while their team does all the work. This is one of those cases where indirect ownership is more beneficial for me as an investor rather than some of the other investments I make outside of the market.   Realty Income When I look at Realty Income compared to its peers, which consist of Federal Realty Investment Trust (FRT), Regency Centers (REG), Kimco Realty (KIM), and National Retail Properties (NNN), I think Realty Income is trading at a good valuation. Realty Income is expected to generate $4.22 per share of funds from operations (FFO) in 2024. FFO to REITs is similar to EPS in terms of traditional equities. Realty Income is trading at a price to FFO of 12.33, which is slightly below the peer group average of 12.98. I always want to make sure I am not paying more than the high end of the peer group for a company's FFO, and the fact that Realty Income is trading below the peer group average is bullish for me.   Steven Fiorillo, Seeking Alpha I always look at the net debt to EBITDA because I don't want to invest in an over-leveraged REIT. Realty Income has a net debt to EBITDA ratio of 6.04x, which is the middle of the road for the peer group, with the average being slightly lower at 5.93x. This doesn't bother me because Realty Income has a long track record of generating substantial returns for its shareholders while scaling their business for decades. Realty Income is in a respectable range where the amount of EBITDA generated is more than enough to manage their liabilities.   Steven Fiorillo, Seeking Alpha Realty Income's monthly dividend can work its magic without share appreciation Realty Income is an income investment for me, and I will model why I am not concerned about appreciation. There will always be a debate between investing for capital appreciation and income. Hopefully, this section will shed some light on how we can live in harmony together. There isn't one specific way to invest, and when it comes to personal finance, everyone's needs and goals vary. I allocate capital toward index funds every month, income investments, and individual equities. I don't look at income investing as a replacement for another type of investment, but I use income investing as a tool to build my financial roadmap. When I retire, I would like to generate enough capital from my income investments to live off of without having to touch any of my other investments. This will allow me to use my other resources however I like in retirement. The reason why Realty Income is becoming a bigger position in my income portfolio is because of how powerful reinvesting the monthly dividend can be. Realty Income has grown its dividend at a 4.3% CAGR since 1994 and has declared 644 monthly dividends. Realty Income has provided shareholders with 105 consecutive monthly increases and has paid $51.76 in dividend income since inception. Today, Realty Income pays $3.08 per share, which is a 5.93% yield, has grown its dividend for 26 consecutive years, and has a 5-year dividend growth rate of 3.59%. I am going to model how impactful an initial investment in Realty Income can be by simply reinvesting the dividends for the next 20 years.   Seeking Alpha To create these models, I used a dividend reinvestment calculator and factored in the monthly dividend, an initial yield of 5.9%, $0 in future contributions, and an expected annual dividend increase of 2.98%. I was a bit conservative and decided to pick a number that was slightly under Realty Income's current 5-year dividend growth rate, and I am doing two models. The first model will assume 3% annualized share price appreciation, while the second model takes no share growth into consideration. Both models will start with 1,000 shares. I think the results may be surprising in some cases. In model 1, we start with 1,000 shares and assume 3% annualized growth. The initial investment would be $52,020, and the 1,000 would be expected to generate $3,072.90 of annual dividend income. Over the 20-year period, $157,976.89 of income would be generated. Reinvesting these dividends over the 20-year period would increase the initial share base by 213.81% to 3,138.09. The future annualized income would have grown by 480.06% from $3,072.09 to $14,751.85. Realty Income's share price would have grown to $93.91, and the ending balance would be $294,693.87, which is a total return of 466.77%. While there was some share growth, the total return would be more than 4.5x over 2 decades, but the amount of income Realty Income would generate is $17,824.75. This is why I am very bullish on income investing as part of my investment mix because the initial investment completely pays for itself, and after 2 decades, Realty Income would be generating $1,485.40 in monthly income.   Steven Fiorillo, MarketBeat In the second model, I kept all of the same assumptions as in model 1, except I have the share price staying flat throughout the next 2 decades. I did this because I wanted to show how powerful Realty Income's dividend could be even if the share price does absolutely nothing over the next 20 years. The share count would have increased by 385.23% as it grew from 1,000 to 4,852.31 shares. Due to the share price staying flat rather than appreciating, more shares could be acquired, which would correlate to more dividend income being generated. There would be $192,409.82 of dividend income generated, which is 269.88% of the original investment over the 20-year period. After the 20 years, the investment in Realty Income would be generating $28,172.70 on an annual basis, which is $2,347.73 per month. While the initial investment would be worth $252,296.03 in a share price environment that stayed flat rather than $294,693.87 from the first model, the amount of income being generated would be 58.05% more. In either scenario, Realty Income could be a significant component of a dividend portfolio if you have time on your side to let the investment mature.   Steven Fiorillo, MarketBeat Conclusion  I think Realty Income is being sold off due to the uncertainty of rates impacting the real estate market. Realty Income is a solid REIT, and I think the recent sell-off is a buying opportunity. Realty Income's dividend profile is second to none, and if you have time, the powers of compounding can be beneficial. Realty Income is one of my preferred real estate investments, as I would rather invest in REITs than physical real estate to generate cash flow. For me, income investing is one component of my overall investment mix, and even if the price of Realty Income stays flat over the next two decades, it can turn out to be a great investment by just reinvesting the dividends. Realty Income could be in for a rough patch, and it may retest its 52-week lows before we get clarity on a Fed pivot, and if it does, I will just keep buying more because I am looking at the long-term benefits rather than the short-term volatility.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2427000814"}