Realty Income Corporation (NYSE: O) is by far the most popular real estate investment trust (REIT) on Seeking Alpha. The company is followed by more than 223,000 people and publishes many new bullish articles every week.
but nevertheless The popularity has exploded, and the company’s stock price has plummeted recently, and its current valuation is at an all-time low:
Is this a historic buying opportunity?
Or should you sell before taking further losses?
Below I share my latest thoughts. I discuss the company’s fundamentals, current valuation and latest news.
Real Estate Income: Q2 2023 Update – Buy or Sell?
Let us first give credit where it is due.
Real Estate Income is very popular these days and deserves a lot of praise.
It has one of the best records in the entire REIT market (VNQ), dividends have increased for nearly 30 consecutive years, with an average annual return of 15% since listing in 1994.
That’s better than the track record of Warren Buffett’s holding company, Berkshire Hathaway (BRK.B ):
Also, if you look at the fundamentals of the company, it does have a lot of strength.
It has a large $47 billion portfolio of defensive “Grade A” net lease properties that generate steadily rising rental income. If you’re not familiar with net lease properties, these are primarily service-oriented, single-tenant properties such as Walmart (WMT) grocery stores and CVS Pharmacies (CVS).
During my private equity days, these are some of my favorite real estate investments because:
- Their long initial lease terms of approximately 15 years allow for highly predictable cash flow even during recessions.
- The lease includes automatic rent increases of 1-2% per annum, which may not seem like much, but it does add up over time.
- Finally, the tenant is responsible for all property costs, including the maintenance of the property.
As a result, the risk-reward ratio of net lease real estate investing is often quite compelling, especially when you’re as diversified as real estate income.
Realty Income then combines this defensive business model with an industry-leading balance sheet with low debt and long-term staggered debt maturities.
It’s one of the few REITs with an A- investment grade rating, which gives it access to cheap capital to keep acquiring more properties.
Taken together, Realty Income has an excellent portfolio, scale advantages, and a solid balance sheet with access to relatively cheap capital.
Coupled with its track record, it has earned it a cult following and solid reputation.
But before you rush into buying the company’s shares, you also need to consider the other side of the coin, because Real Estate Income has its problems, too.
The Hidden Problem of Real Estate Income
In recent months, I have pointed out that real estate income faces a major challenge: Get too big!
Therefore, it had to step out of its sphere of competence and enter other real estate industries and regions:
but you can’t be”know-it-all” That’s really my main criticism of the company so far.
I am concerned that the company faces a dilemma: either continue to focus on its core competencies and accept slower growth rates due to its size, or exit core competencies to achieve faster growth, but this increases risk and may dilute quality its investment portfolio.
Realty Income has clearly opted for the second option, and to its credit, it’s worked out pretty well so far. Despite its size, it still manages to maintain a target annual growth rate of about 5%.
But where is the limit?
Just recently, Realty Income announced another new type of investment. It is forming a joint venture with Blackstone (BX) and investing in the Bellagio in Las Vegas. Importantly, this investment includes a preferred stock component, which is new to Realty Income. The CEO had the following to say about the deal:
Sumit Roy, President and CEO of Realty Income, said: “Credit investing has a natural connection to our traditional business, allowing us to provide additional value to our clients while leveraging our expertise in deal sourcing and structuring, real estate and credit underwriting and monitoring. core competencies.”
So Realty Income is once again entering a new vertical.
Some of you may love this…others may worry about this new development.
The REIT market has historically rewarded companies that specialize in a particular area of real estate and become experts in it. This makes sense because you can’t be an expert on everything, and given that investors can diversify by holding REIT portfolios, diversification within a REIT doesn’t do any good.
As a result, REITs that have a diversified portfolio across multiple real estate sectors (also known as “diversified REITs”) have historically commanded far lower valuation multiples than REITs that specialize in one real estate sector fund.
Will real estate income face permanent multiple compression from its recent investments outside its core circle of competence?
Only time will tell.
I think Realty Income is an exception where the market doesn’t punish it too much for its reputation and cult following, and it’s really an exception for REITs.
But regardless, growth will only get harder as Realty Income gets bigger and loses focus, and ultimately, I think that will be reflected in its valuation.
This might explain why Realty Income has underperformed its smaller and more focused peers like Essential Properties Realty Trust (EPRT) recently:
After reading this article, you may now think that I am bearish on Real Estate Income, but that’s not the case.I actually own a small position as part of my retirement portfolio.
After the recent crash, Realty Income’s dividend yield is now 5.5%, near its highest level since 2016. (The only time yields were higher was briefly after the 2020 pandemic crash.)
The company could grow too large for its own benefit, which could slow its future growth, but that’s reflected in its low valuation and high yield right now, and doesn’t require much growth Attractive total returns can be achieved.
Additionally, I think interest rates will return to lower levels over the next few years, which could push property income valuation multiples higher and thus provide some upside.
I still think some of its peers are even better investment opportunities in today’s market but if you’re a conservative investor looking for safe monthly dividend income then at these levels property income isn’t A poor choice.
It’s not perfect, but no investment is perfect. As long as you keep an eye on these risks and don’t overpay, you should get good returns over time from owning Real Estate Income stocks.