TThe economy has been on a rollercoaster since the start of the pandemic in 2020. It was strong heading into the pandemic, which then triggered a short, deep recession. Heavy stimulus payments followed, which unleashed inflation, and now the US could be (or enter) a recession. That’s a lot to manage for any business.
Income-oriented investors tend to be older and therefore have less ability to withstand volatility. Real estate income (NYSE:O) is a great stock for them: it has a very stable trading pattern and a decent return as well. Here’s why you might want to consider it for your portfolio.
How Triple Net Leases Differ
Realty Income is a real estate investment trust (REIT) that focuses on freestanding, single-tenant properties under a type of arrangement called a triple net lease. Most leases tenants are familiar with are gross leases: the tenant is responsible for paying rent and the landlord handles most other expenses such as taxes, insurance, and maintenance. The typical lease for an apartment is a gross lease.
In the context of triple net leases, the tenant bears these charges. These leases are much more common for stand-alone properties such as industrial warehouses and single-tenant retail stores. Triple net leases are generally longer term agreements and contain some form of annual increments. Both parties benefit from the security offered by these arrangements.
Realty Income has pretty much seen it all economically
Realty Income has been around since the late 1960s and has been through all kinds of different economic environments. He was able to weather the financial crisis, the pandemic, and now faces inflation like we really haven’t seen in 40 years.
The REIT’s secret sauce is its tenant base. Its typical tenants are in highly defensive industries, meaning they are largely insulated from economic downturns. The ideal tenant for Realty Income is a pharmacy, convenience store, or dollar store. Even though the economy is going into a deep recession, people are still buying medicine and snacks and looking to save money.
In 2020, at the height of the pandemic, Realty Income increased its dividend three times, while most other REITs cut theirs. Most of the company’s tenants were in businesses deemed essential, so its tenants were allowed to remain open. There were struggling tenants like theaters and fitness centers, but overall the business weathered the crisis as well as one could ask.
Rising rates and inflation seem like non-issues
So far, rising interest rates and inflation have yet to hurt the company. Realty Income recently announced that adjusted funds from operations (AFFO) per share increased 10.2% in the quarter. Funds from operations is a REIT-centric financial metric frequently used to describe earnings. Because REITs have a lot of depreciation and amortization (which are non-cash charges), earnings under generally accepted accounting principles (GAAP) tend to underestimate the cash flow capacity of the business. AFFO does a better job of that.
Interest rates have gone up, and it’s generally a tougher environment for the consumer and retailers. Despite this increase, the occupancy rate has increased and stands at 98.9%, the highest in 10 years. The company is expanding its operations overseas and has raised its forecast for real estate acquisitions to more than $6 billion for this year. He also increased advice at all levels. Suffice it to say that rising rates and inflation are not a problem for the company, at least so far.
Realty Income is a dividend aristocrat, meaning it has at least 25 years of consecutive annual dividend increases. It recently increased its monthly dividend in June and now yields 4.1%. While there are REITs that earn more, Realty Income is a world-class triple net rental REIT and should have a premium multiple. The $2.97 annual dividend is well covered given that the company expects the AFFO to be between $3.84 and $3.97 per share. This very stable company with a good yield should be considered a basic holding for income investors.
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Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.