Does Realty Income’s 4.5% Dividend Yield Make It Worth Buying?

The novel coronavirus has had an uneven impact on the economy. Some investments, like technology stocks, have largely brushed off the crisis. Others have not. Real estate investment trusts are among the latter group. REITs have gotten absolutely smoked in 2020, though they are starting to rebound now. Among the latter group, Realty Income (NYSE:O) stock has had one of the swiftest recoveries.

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It’s understandable why investors are running back into Realty Income. The company is arguably the nation’s leading triple-net lease operator. A triple-net lease is a structure in which occupants are responsible for all the costs of a property. The tenant pays not just the rent, but also property taxes and utilities.

Generally, that’s a favorable arrangement for the landlord. Triple-net lease REITs have done well over the past decade, and Realty Income has led the pack. In fact, Realty Income stock has generated double-digit-percentage annual returns over the past 20 years.

It also has raised its dividend each year since it went public. And Realty Income was one of the first REITs to start paying a monthly dividend. These features have made it a core holding for many retirees and other income investors.

Realty Income is clearly an excellent company. But has the coronavirus changed the firm’s outlook? The appeal of REITs like Realty Income is based on their dividends. So let’s start by analyzing Realty Income’s dividend.

Putting Realty Income’s Dividend in Perspective

Realty Income is paying an annual dividend of $2.80 per share. Its dividend yield is 4.45%. Over the past five years, Realty Income’s payout has increased at an annualized rate of 4%.

So the REIT could increase its dividend by 4%, or about 10 cents, this year. But its dividend increases will likely be slower until the current recession ends.

Over the past decade, O stock has usually had a dividend yield of between 4% and 5%. Its lowest yield was 3.5%, which it reached in 2013, 2016, and again at the beginning of 2020. By contrast, the REIT’s yield approached 6% in 2010, 2014, and in March of this year.

Buying Realty Income stock when its yield was under 4% has almost always worked out poorly. Meanwhile, buying Realty Income when its yield was over 5% has generally provided quick capital gains, as the shares have usually subsequently rallied, pushing the yield down to its usual range.

The current yield, however, is not providing investors with a strong buying signal or a strong selling signal. In fact, the REIT’s yield is now about at its average historical level. So, based purely on the company’s dividend, the REIT’s current price is fair.

Which Direction Will Realty Income Stock Go Next?

But the economic environment has changed a great deal. Realty Income is having trouble collecting rent from its tenants. In May, it received 82% of the rent that it was supposed to be paid, based on its contracts. That represented a slight decline from April, when it collected 84% of the rent that it was owed.

There’s an optimistic and a pessimistic way to interpret these figures. On the plus side, Realty Income has received a much higher percentage of the rent it’s owed than many of its peers. Other triple-net-lease REITs have collected as little as 60% of the rent they’re owed since the crisis started.

Realty Income’s focus on high-quality investment grade tenants has saved the day. The company’s top tenants include the likes of Walgreens (NYSE:WBA), Dollar General (NYSE:DG), and FedEx (NYSE:FDX). Those are all big enterprises with strong balance sheets that provide essential services to the community. Realty Income isn’t primarily renting to apparel stores, restaurants, or other weaker retail sectors.

On the other hand, collecting 82% of the rent owed isn’t great; usually Realty Income collects just short of 100% of the rent it’s owed every month.

And the decline in the REIT’s collection rate in May isn’t encouraging, either. Since the government provided financial aid last month, while many states started to reopen, some investors may have expected Realty Income’s rent collections to stabilize or even start to increase in May.

The Verdict on Realty Income

Realty Income’s fortunes will move in conjunction with the economic reopening trend. If there’s no second wave of the virus and economic activity steadily picks back up, Realty Income should climb a great deal.

The shares could realistically get back to $75 or $80, the levels at which they traded before the crisis.

However, on any signs of a prolonged economic slowdown or a resurgence of the virus, Realty Income stock could tank once again. As I noted, the shares’ valuation is currently at normal levels. Thus, they are significantly overpriced if Realty Income’s rent collection levels stay around 80% instead of rising to their normal proportion of nearly 100%.

Investors have priced in a healthy recovery for Realty Income and many other REITs. As long as the macro situation remains upbeat, that trade will work out. But given the current economic risk,  I would only buy Realty Income stock if it falls below its fair value. But it’s clearly a high-quality REIT, and long-term investors who buy it at its current price will probably do fine.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2020/06/does-realty-incomes-4-5-dividend-yield-make-it-worth-buying/.

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