Realty Income CorporationO

Morningstar Rating

Stock Research and Analysis

by Todd Lukasik, CFA

Employing a conservative strategy, retail real estate investment trust Realty Income has historically delivered consistent, reliable growth. We believe Realty Income has built a narrow moat around its business, but the next year or two will present the most challenging operating environment retail REITs have ever faced. Read more

Bulls Say

Realty Income is built to provide a reliable, slow-growing, monthly dividend. Its tenants sign long-term leases with regular rent bumps tied to inflation.

With a conservative capital structure and remaining capacity available on its credit facility, Realty Income should be able to take advantage of any attractive property portfolio acquisitions that become available.

As a result of its long-term leases, Realty Income has an average of 4.1% of its total rental revenue up for renewal annually over the next five years, which is relatively low compared to other retail landlords. This should provide some protection if rents fall over the near term.

Tenants occupying Realty Income's properties are responsible for the property taxes, insurance, and maintenance, reducing Realty Income's property-related expenses and resulting in outstanding EBITDA margins that have averaged 92.2% during the past five years.

Realty Income applies the investing principles of Benjamin Graham and Warren Buffett to its sale-leaseback transactions with retailers. It builds a margin of safety into its business by purchasing its tenants' most profitable stores and ensuring that they will still be able to cover rent payments with cash, even if store performance deteriorates somewhat. Read more

Bears Say

Management freely admits that Realty Income had a "fairly easy operating environment in recent years" and that things could get much tougher in the future.

Realty Income has concentrated its leasing efforts on less-than-investment-grade tenants, which might suffer disproportionately during economic downturns.

When Realty Income's largest tenant, Buffets, filed for bankruptcy, it rejected 12% of its leases and negotiated a 13% reduction in rent on its remaining leases. Given the current economic head winds facing U.S. consumers, it is possible that additional Realty Income tenants will file for bankruptcy and cancel leases or demand lower rent.

With the contraction of consumer credit, retail sales are resetting at meaningfully lower levels. Rents collected by retail landlords will follow in time.

If long-term interest rates rise more than we expect, this firm's cost of capital would increase, pressuring asset values and reducing cash flow. Read more

Strategy

Preserving invested capital and generating additional cash flow to pay monthly dividends that increase over time are the top priorities at Realty Income. The firm acquires single-tenant, freestanding, retail properties that it leases on a long-term basis to retailers that provide goods and services used regularly by consumers. Read more

Management

Realty Income receives excellent marks in our stewardship model. CEO Tom Lewis has more than 25 years of experience in real estate and has been with Realty Income since 1987. Management's interests are well aligned with those of shareholders. Executive compensation is weighted toward performance bonuses, including stock awards, and directors' pay is heavily weighted toward stock. Read more

Profile

At the end of 2008, Realty Income owned 2,348 properties, more than 99% of which are freestanding, single-tenant retail properties in 49 states that averaged 8,130 square feet of leasable space and totaled 19 million square feet of leasable space. Read more

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