Realty Income Corp (NYSE:O) has a current yield of 4.5%. By many investors’ standards, that makes O stock overpriced. REITs have to pay 5% or more, or it’s just not worth it — so goes the rationale, anyway.
Without debating quality versus quantity, Realty Income is an effective business whose assets have stood the test of time.
It would be nice to buy O stock in the mid-$40s, but as the Rolling Stones once said, you can’t always get what you want. Realty Income stock hasn’t traded in the mid-$40s consistently since June 2015.
As InvestorPlace contributor Ian Bezek recently mentioned, Realty Income’s occupancy rate never fell below 95% during the financial crisis, the last time retail businesses took a beating. That’s huge, given retail is struggling once more.
Investors should be more concerned about the quality of assets owned because when the “you know what” hits the fan, a REIT’s yield won’t be worth the paper it’s printed on — unless, of course, it has top-drawer assets.
Big doesn’t always equate to better.
If you look at O stock’s valuation over the past decade, by almost any metric, it’s not trading at an exorbitant multiple. The share price may be a bit higher than you’d like, but plenty of investors have continued to buy O stock because they understand the importance of consistent monthly dividends.
The consistency of payout, to me, is far more important than the size of the payout, especially if you rely on the income to live.
As the headline alludes, I see O stock as a buy, albeit with two conditions. Most people are going to disagree with me about the first one, and the second is a hedge against being wrong about its valuation.
Homeowners Need Not Apply
It’s been almost a year since REITs got their sector, separate from their long-time stablemates in financials. Since that time, the Vanguard REIT Index Fund (NYSEARCA:VNQ) has fallen by 4.9% between September 1, 2016, and June 13, 2017.
I thought this was supposed to help investors, not hinder them. Perhaps this is the best indication REITs, in general, are pricey at the moment.
Whatever the reason for the VMQ drop, my first condition is that you should only buy O stock if you don’t own a home.
Before real estate was separated from financials, you could argue that, to own the best companies the financial services industry had to offer, you also had to accept the real estate business as part of that deal.
Now that you don’t have to make that compromise, if more than 50% of your wealth is tied up in real estate, why would you choose to own more? This is an especially vexing question for those who still have a mortgage. Doing so is akin to piling interest rate risk on top of interest rate risk.
But, if you don’t own a home, go for it!
Maybe O Stock Is Overpriced
As I like to say, investing is all about probabilities.
While I don’t think Realty Income will retreat to $45 any time soon, due to rising interest rates, it’s certainly within the realm of possibilities.
So, rather than buy O stock exclusively, this is the perfect situation to own a REIT. You like O, you like real estate, but you want to diversify away some of the risk.
So, you buy VNQ, which gives you Realty Income stock — the 13th largest holding with a weighting of 1.8% — and this allows you to focus on your core portfolio of stocks while still owning another asset class.
Bottom Line for O Stock
If you own a house and still want to buy O stock, by all means, go ahead. Realty Income is an excellent company.
I just see it as overkill.
However, others could argue that residential real estate is more closely correlated to stocks than REITs, no matter the type.
So, it comes down to what makes the most sense for you and your family.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.