In an earlier article, I discussed the items I look for in Real Estate Investment trusts. I will cover those items in the stock analysis below.
The company has managed to increase its Funds from Operations (FFO)/share from $1.47 in 2003 to $2.41 by 2013. At the same time, dividends per share increased from $1.18 in 2003 to $2.15 by 2013. The FFO payout ratio has increased from 80% to 89% over the same time period, which is not something I would like to see. However, this ratio has been going down since hitting a high of 94% in 2010. As you can see, there was a big jump in FFO/share and dividends per share in 2013, as a result of the $3.2 billion acquisition of American Realty Capital Trust. In addition, the company also invested $1.5 billion in 459 properties throughout the year.
Year
|
2013
|
2012
|
2011
|
2010
|
2009
|
2008
|
2007
|
2006
|
2005
|
2004
|
2003
|
FFO
|
2.41
|
2.02
|
1.98
|
1.83
|
1.84
|
1.83
|
1.89
|
1.73
|
1.62
|
1.53
|
1.47
|
DPS
|
2.15
|
1.77
|
1.74
|
1.72
|
1.71
|
1.66
|
1.56
|
1.44
|
1.35
|
1.24
|
1.18
|
DPR
|
89%
|
88%
|
88%
|
94%
|
93%
|
91%
|
83%
|
83%
|
83%
|
81%
|
80%
|
Occup
|
98.2%
|
97.2%
|
96.7%
|
96.6%
|
96.8%
|
97.0%
|
97.9%
|
98.7%
|
98.5%
|
97.9%
|
98.1%
|
The other metric I like to look at with REITs is occupancy ratios. As Realty Income has been expanding over the past decade, it is important to see that this has not resulted in additions of properties to mask a deterioration in existing locations. The occupancy levels dropped during the financial crisis, but then recovered and are close to where they were last year.
The Realty Income of today is much larger and more diversified that the Realty Income of 2003. The top ten tenants account for less than 45% of revenues:
The record low interest rates have been a boon for Real Estate Investment trusts. Investors have fled the sector, attracted by high yields relative to US Treasuries and CD’s. Realty Income has been able to sell $750 million worth of ten-year notes in 2013 at 4.65%/year, which is pretty low. However, this influx of capital has led to many companies competing for assets, which pushes the initial yields on those properties lower. As a result, when debts need to be refinanced in a decade from now, and interest rates increase substantially, it is quite possible that those result in lower profits down the road on those issues. This could be of particular concern since rents usually increase at slightly less than the rate of inflation. Another potential concern I see is the increased deal making in the sector, in an effort to build the largest triple-net company out there. With Realty Income, this is not an issue, although it is a risk I am watching carefully.
Of course, the risks that I am presenting are just something to watch out for. I truly believe that there is much more growth ahead for Realty Income. This would be fueled by property acquisitions that provide incremental free cash flow to grow dividends into the future. Historically, the company has done a good job in evaluating tenants, and filing in occupancies by getting new tenants or selling those properties.
The company has managed to earn a cap rate of 7.10% on its 2013 property acquisitions and a cap rate of 7.20% on its 2012 property acquisitions. This compares well relative to the interest rates on notes sold in 2013, and the average interest rate on its $3.20 billion in notes payable of 4.90%. In addition, it compares well to the 5.30% interest on its $755 million in mortgages payable. The company finds the cash necessary to grow by issuing common stock, preferred stock and debt to investors. Therefore, it is essential that there is a positive spread between cap rates on property investments and cost of capital.
I really like the stability of the long-term triple-net type leases that Realty Income uses to rent out its properties. The average lease term for the 3896 properties at the end of 2013 was 10.80 years, which should translate into stability in cashflows that are used to pay the monthly dividends to shareholders. Those leases provide for rent escalations over time, and also make the tenants pay for maintenance expenses, taxes, insurance, utilities.
I do not foresee dividends growing faster than 4%/year, unless of course another big accretive acquisition is made. This would be fueled by acquisitions as well as annual increases in rents from the properties that the company owns throughout the US.
Overall, I like Realty Income, and intend to hold my position for as long as possible. However, I would like to receive a higher starter yield on an investment in this REIT. Currently, the REIT yields 5.10%, although the yield was as high as 6% in December 2013. Given the low growth expectations, paying a lower entry price might be helpful in generating good returns from Realty Income. This is particularly true given the fact that W.P. Carey (WPC) and American Realty Capital Properties (ARCP) yield 5.50% and 8% respectively.
Full Disclosure: Long O and ARCP
Relevant Articles:
- Five Things to Look For in a Real Estate Investment Trust
- Four High Yield REITs for current income
- Are we in a REIT bubble?
- My Dividend Retirement Plan
- Realty Income (O) Raises Dividends by a Record 19.20%