Income and Growth in One REIT
Realty Income, the #3 Best Buy in our REIT portfolio, is going gangbusters and should benefit from powerful economic trends.
Gains in consumer spending should continue well into 2016. The Commerce Department estimates that this year’s growth in consumer spending will surpass the 10-year average of 2.7%. Low oil prices and an improving economy mean Americans will continue opening their wallets, with retail businesses and landlords of retail properties reaping the rewards.
That includes Realty Income. It owns 4,538 properties in 48 U.S. states and Puerto Rico, with about 79% retail. Realty’s other segments include industrial (12.8%), office (6.1%) and agriculture (2.1%).
Although heavily devoted to retail, Realty spreads its leases among 240 commercial tenants in 47 industries, with none accounting for more than 7% of the portfolio. Some of Realty’s tenants include nationally recognized firms such as FedEx, Walmart and Dollar General.
Over the past 20 years, Realty’s shareholders enjoyed strong dividend growth and price appreciation. Since its initial public offering in 1994, Realty bested its benchmark REIT index yield 20 out of 22 years and averaged 17% for its compounded annual total returns versus its benchmark of 11%. The dividend, which currently yields 4.1%, grew at a 5% compounded annual rate during the same period.
The company consistently generated higher cash flow by expanding its portfolio and raising rent regularly on existing leases. These increases include both fixed and variable rent increases that are based on a percentage of the tenant’s gross sales, which improve along with the economy.
Income-Oriented
The increased cash flow, known as funds from operations (FFO) in the industry, enabled Realty to raise its dividends often. The company is so proud of this track record that it even refers to itself as “the monthly dividend company” on its website. Recently, Realty announced its 73rd consecutive quarterly increase, boosting its annual dividend 5% over last years rate to $2.382 and on par with its 20-plus-year average.
Although the board of directors decides whether to raise the dividend, any increases generally are dictated by the REIT structure. As long as FFO continues to increase, the REIT is obligated to return 90% of its income to shareholders, which it does through monthly dividends.
To continue its long-standing streak of strong performance, the company looks for sources of growth. Last year, Realty added 286 new properties for a total of $1.26 billion, a near-record number of acquisitions. Growth was also driven by a same-store rent increase of 1.3% on its 3,636 properties for a total of $794.4 million.
As demand for retail space intensified, occupancy improved from 98.3% to 98.4%, the highest since 2005, despite a record number of lease expirations on 253 Realty properties during the year.
Its 2015 performance allowed the REIT to sustain its tremendous dividend growth. In 2015, full-year FFO rose 7.4% to $2.77 per share, with adjusted FFO per share up 6.6% to $2.74.
Realty’s Growth Story
Since 2010, Realty has averaged $1 billion in acquisitions annually. The company funded its 2015 shopping spree mainly by issuing $1.2 billion in equity. This left about $1.63 billion of Realty’s $2 billion credit available for future acquisitions. The company fully expects to meet its 2016 target of adding another $750 million in assets.
Management provided FFO guidance this year in the range of $2.82 to $2.89 per unit, which represents a 1.8% to 4.3% increase from 2015. FFO is expected to be $2.85 to $2.90 per unit, up 4% to 5.8% compared with last year. If Realty meets its FFO target and the economy keeps improving, the streak of generous dividend hikes should continue.
Realty has a strong reputation as a well-supported dividend payer, but it also has generated enviable equity returns to the tune of 17% over the past 22 years. As income-hungry investors recognized this retail REIT’s value and strength, they bought up shares, sending Realty’s price to an all-time high in March 2016.
After retreating slightly from its February high, Realty is still the top performer in the REIT portfolio, returning about 20% since we recommended it last year. But this performance pushed the price well above our recommended target. Realty’s current forward price-to-FFO of about 20.9% represents a premium to its nearest competitors and may make it too expensive to jump onboard now.
To lock in a better yield, buy Realty Income on dips below $55.
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