Key Points
Realty Income has a 5.6% dividend yield that is well-covered by its cash flow.
Thanks to the high-interest environment, its shares are attractively priced as a long-term investment.
The company has increased its dividend for 117 consecutive quarters.
The vast majority of dividend stocks pay quarterly. Realty Income (NYSE:O) pays monthly and has now made 675 consecutive monthly dividend payments to investors. That alone is enough to get income investors' attention. But the reason I keep buying this real estate investment trust, or REIT, is that the dividend is well covered, the portfolio is almost fully leased, and the stock has held up far better than the market when things get rough. And with a dividend yield of more than 5.6%, it looks like an extremely attractive entry point.
I've owned Realty Income in my portfolio for more than a decade, and I keep adding shares over time. Here's why.
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The dividend looks safe
Realty Income's dividend is about $3.26 per share annualized, for a yield of roughly 5.6% at the current price, and it has increased for 116 straight quarters. The best measure of safety for a REIT is AFFO (adjusted funds from operations), which is essentially its free cash flow.
In the second quarter, AFFO was $1.09 per share, and management guided full-year AFFO to $4.44-$4.45 per share. Divide $3.26 by that, and you get a payout ratio of about 73%, which leaves room. For context, AFFO payout ratios in the 70%-80% ballpark are quite common and healthy for real estate investment trusts.
Realty Income's properties are in demand, too. Occupancy is around 98.8% and has been at or near that level for many years. There are annual rent increases built into the leases, and when leases are renewed, the new rent typically exceeds 100% of the old rent.
The rate objection
Higher rates raise Realty Income's cost of capital. It's a serious drag on REITs and is the primary reason why real estate stocks have underperformed the S&P 500 on a total return basis in recent years.
But Realty Income is still finding ways to put money to work. In fact, during the second quarter, it invested $2.6 billion at an initial cash yield of 7.3%. As long as it can buy properties that yield more than they cost to fund, higher rates weigh more on the share price than on the business. Those aren't the same thing. The spread is what I'm watching, not the acquisition yield on its own.
What you're signing up for
On one hand, Realty Income has a solid track record of holding up well during turbulent stock markets. Across the S&P 500 pullbacks of 10% or more since its 1994 listing, Realty Income posted an average total return of -2.6%, compared with -22.6% for the index.
Now for the not-so-flattering part. This isn't a fast grower and likely never will be. Your realistic total return is the dividend yield plus low- to mid-single-digit AFFO growth. Over its 30+ years as a publicly traded REIT, Realty Income has delivered market-beating total returns. With yield plus AFFO growth, you could see a long-term total return in the low double digits. But this isn't going to be a stock that doubles or triples in a few years. It's also worth noting that REIT dividends are mostly taxed as ordinary income, so an IRA is the best home for this one if you have room.
The bottom line
A nearly 6% dividend yield paid monthly, covered by cash flow, from a portfolio that's nearly fully occupied. That's not exciting, and that's the point. But I own the stock, have added to it many times over the years, and plan to continue to reinvest and allow my investment to compound until I need the income. Realty Income offers an excellent yield and strong total return potential, with a business model that allows me to sleep well at night.
Matt Frankel, CFP® has positions in Realty Income. The Motley Fool has positions in and recommends Realty Income. The Motley Fool has a disclosure policy.