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Realty Income Corporation (NYSE:O) is perhaps the most popular blue-chip real estate investment trust, or REIT, that pays a monthly dividend for income-thirsty investors. We have been closely watching the stock looking for a tactical entry point for long-term investment. Let us say that this stock offers investors an attractive current dividend yield now approaching 6.3%. This is now a very high yield, and has drawn buys from investors the entire way down on this decline thanks to its dividend growth streak over the last two decades.
Make no mistake, this company has a strong business model and a relatively strong balance sheet. Right now it is still one of the best houses in a neighborhood that is deteriorating. The fact is that the recent moonshot in interest rates has led O stock, and so many other REITs, to take a shellacking. The thing is, we have actively avoided REITs for a number of quarters, as these were clear short targets for our traders. Those who have been long, we have encouraged the sale of covered calls for some income to stave off the so-called paper losses. We still believe that REITs generally are getting closer to being strong buys, but we first need confirmation that rates will settle down. When is the time to buy? Some say now. Some said “now” three months ago. Some said now six months ago.
Our take is that we will become more bullish when the likelihood of rate cuts grow. This is our opinion. REITs for the most part are seeing a generational buying opportunity brewing, but the carnage is not over yet. In the meantime, we have sought alternative sources of income and trades over the last 5 or so quarters as REITs have been crushed.
We have been asked if the paper losses on REITs will be recovered? For the most part yes, but it will take a number of quarters, with dividends along the way. Here is the deal: Realty Income stock has been obliterated, but if investors start scaling in now, particularly if you are young, you can let the magic of compound interest work its magic over the next few decades. Come retirement, you will have a wonderful stream of income.
The company is not going out of business. This is simply the start of a fire sale in the sector. It is not over yet. Buying now for the long term will likely pay off. We prefer to buy when the sector, and/or a stock, is set up for a rebound so that we limit losses, even paper losses.
Is Realty Income a buy? In the very-near term, it is best to avoid if you are worried about your capital in the next two quarters. However, for investors, sales like this do not come around too often.
The ideal time to buy will in our opinion be in 2024. Although we are under a higher-for-longer rate environment, 2024 is where we see REITs bottoming out as we see the Fed rate hike campaign coming to an end, as we have discussed this in depth among our investing group membership. We also see the first rate cut in H2 2024. It is not just the fact that rates are high and this makes financing new properties more costly, or the refinancing of debt. Another issue is that it adds selling pressure, as investors are happy to move to cash or bonds and collect 5%, rather than take on equity risk. But as REITs go, O should be at the top of your shopping list after it has been obliterated. Buy why?
For our many followers who are not familiar, Realty Income owns and manages a diversified portfolio of commercial properties leased to single tenants on a long-term, triple net basis. In our estimation, Realty Income’s business model is well-positioned to continue to generate recurring revenues and withstand economic downturns. The company provides capital to middle-market regional operators and national retail chain store operators by acquiring and leasing back their retail sites over long-term periods, typically in excess of ten years. Triple-net leases are favorable as under a triple-net lease, the tenant is responsible for all property expenses, including taxes, insurance, and maintenance. Realty Income’s current weighted average remaining lease term is about 9.6 years.
At the start of Q3, Realty Income owned more than 13,000 properties across the U.S., U.K., and other European nations. The company leases property to around 1,300 clients. This low asset and client concentration is a positive factor for the company’s sustainable business model over the long term.
One of the major things to consider for a REIT is the tenant base and the occupancy rate at properties. Despite all of the ups and downs over the years, Realty Income’s occupancy rate is close to 99%. Translation? This is a high-quality operator. The portfolio is sound and the company will keep generating recurring revenues for many years to come.
One of the risks that is often cited is that the vast majority of its rental income comes from retail. In fact, 3/4 of the tenant base is retail. However, grocery stores and convenience stores are the two largest industries, accounting for about 19% of the total annual rent. These are recession-resistant businesses. We certainly understand the complaint over brick and mortar retail being a relic of the past with more and more people shopping online, but we do not view this risk as a threat to the life of the business model. Over 90% of the tenant base is resistant to the threat of e-commerce.
What about fiscal performance? We see no signs of imminent distress. The company did of course merge with VEREIT a number of quarters ago, so it saw a boost to annual comps, but the key here is that cash flow remains strong as does funds from operations. Realty Income’s revenues were $3.3 billion in 2022 with net income of $869 million and AFFO (adjusted funds from operations) of $2.4 billion, or $3.92 per share.
In the most recent quarter, net income was $195.4 million, or $0.29 per share, while AFFO was $1.00 per share. The company also invested $3.1 billion in 710 properties and properties under development or expansion at an initial weighted average cash lease yield of 6.9%. There has been and will be some dilution here to raise cash, which is one of the bears complaints and there is merit to it. In Q2, Realty Income raised $2.2 billion from the sale of common stock with a weighted average price of $61.89, while the company also looks to a sales agreement with a number of financers to sell up to 120 million shares of its common stock, which was announced in August.
We still like the balance sheet here, but will keep an eye on leverage. At the end of Q2, net debt to adjusted EBITDA (annualized) was 5.3x. The company had $3.5 billion of liquidity, which consists of cash and cash equivalents of $253.7 million to start Q3. The dividend is covered by cash flow, and that is key.
So what about as we look ahead? The rate environment will be higher for longer. So investors need to be concerned about the debt maturity schedule here. For a full look at the debt maturity, see the recent quarterly filing, but there is some debt due in 2024, with many of the notes due later this decade. At the end of Q2, the company had $1.1 billion in multicurrency borrowings, Their 2023 term loans initially mature in January 2024 and include two 12-month maturity extensions that can be exercised. The company has a $250.0 million senior unsecured term loan, which matures in March 2024. For mortgages payable, a large chunk of principal is due in 2024, $740 million of the ~$830 million outstanding.
In terms of the notes, there are about $16.3 billion of notes, with maturities from 2024 through 2047. Nest year about $850 million in notes are due, with another $1 billion due in 2025. Keep a close eye on new issuances and steps taken to raise money. New notes are likely to come with higher price tags in this higher-for-longer environment, the same with any new mortgage activity that may occur in the future. Going further into detail on this topic is beyond the scope of this coverage initiation, but we will reiterate, read the filings.
After this drastic selloff, which looks to continue, the valuation is at decade lows. If you factor in the debt and current cash levels we noted with the balance sheet, the enterprise value here at decade lows. Enterprise value to EBITDA results of 16x is over a 20% discount the last ten years 10 years. Price to rental revenue is under 9.6X, while the price to book as a paltry 1.1X.
Seeking Alpha
Should you buy Realty Income Corporation now? Well, it depends on your horizon. We like the fact that although it is fractions of pennies, the dividend is consistently raised. The dividend in our opinion is secure. We like the monthly income here. We also like the fact that the yield is now 6.3%.
While the chart looks scary, and there is likely a bit more downside to go, a sub-$48 entry for the long-term is reasonable. We would add in $0.75 blocks from the current price of $48.44 down to $45. If you are patient, you can monitor the situation and wait for the lower end of this range. We see 2024 as the time to get back into REITs broadly speaking, but we have no crystal ball. Regardless of where the actual bottom is, $48 for Realty Income Corporation shares is a great price for the long-term investor.
