There are many things in life I understand, but there are probably even more things that I don’t.
However, I can tell you something that is quite easy for me to understand: real estate.
They always say they’re not making any more land. Well, that’s absolutely true.
Seeing as how land is a finite resource, then, how does one profit from that?
There are many different potential answers to that question.
But I’m going to propose one great answer today that pays steady, rising, monthly cash flow.
How does that sound?
I reached financial independence in my early 30s, which occurred exactly when the passive income my real-life and real-money portfolio of investments generates started to exceed the amount of money my basic expenses in life (like rent, food, transportation, etc.) cost me.
And this portfolio is allocated 100% to stocks.
But not just any stocks.
The stocks in my portfolio are almost all high-quality businesses that have lengthy track records of paying regularly increasing dividends to their shareholders.
Said another way, these are dividend growth stocks.
That’s because I believe investing in high-quality dividend growth stocks isn’t just perhaps the most robust way to build sustainable passive income with which to be financially independent, but it’s also perhaps the easiest way to go about it.
That brings me back around to real estate…
Another way to achieve financial independence via passive income could be to buy up a bunch of properties and rent them out to tenants, collecting fat rental checks month in and month out.
But that might not be as passive as it sounds, right?
You have to worry about screening tenants, maintenance, and the proverbial leaking toilet.
And I’m just scratching the surface here.
I instead collect my own “rental check” another way.
I’m a shareholder in Realty Income Corp. (O).
This is a real estate investment trust (REIT) that buys commercial freestanding properties and leases them out on a long-term basis to tenants on a triple net basis. A triple net lease means the tenant is responsible for net building insurance, net common area maintenance, and net real estate taxes on the leased asset.
Nice!
So Realty Income basically does the hard work for me. They find great commercial properties in solid locations, finance the acquisitions, recruit the tenants, and maintain all the paperwork and headaches.
What do I do?
I simply invest capital in the company through their common stock. I then sit back and wait for my monthly “rent check” to come in via their dividend payout.
Monthly? Say what?
Yep. You read correctly. Realty Income pays a monthly dividend.
Even better, they raise that dividend fairly regularly: they’ve increased their dividend 93 times since 1994 (the year they went public). Breaking it down further, they’ve increased their dividend for 80 consecutive quarters.
That’s the kind of reliability and consistency that I like to bet my financial independence on.
And, as I’ve stated in many of my articles before, you can’t build that kind of reputation and history of excellence if you’re not doing a lot of things right.
So let’s take a look at some of their fundamentals to see if they’re doing it right.
We’ll first look at top-line and bottom-line growth over the last 10 decade.
Revenue grew from $297 million in fiscal year 2007 to $1.1 billion in FY 2016. That’s a compound annual growth rate of 15.66%.
That’s extremely impressive on the face of it, but Realty Income also had some substantial acquisitions in this period. A successful real estate investment trust is always aiming to acquire high-value properties.
In addition, due to the way the capital structure works, REITs issue shares and/or debt to finance acquisitions. The issuance of shares shows us that Realty Income Corp. increased its outstanding share count by over 150% over the last 10 years.
And so, when investigating a REIT, it’s never more important to look at growth on a relative (per-share) basis rather than an absolute basis.
I usually use earnings per share as a primary indicator of relative profit growth, as EPS will tell us how much profit a company is earning per share.
However, extremely high amortization and depreciation expenses that can distort a REIT’s true cash generation ability.
So we use what is called funds from operations or adjusted funds from operations as a measure of profit for a REIT. This is a measure of cash generated by a REIT, which adds depreciation and amortization expenses back to earnings.
Looking at FFO/AFFO growth on a per-share basis over a decade will give you not only a more accurate picture of profit growth, but it will also factor in any dilution that’s occurred.
Realty Income’s FFO per share increased from $1.89 to $2.88 over this 10-year stretch, which is a CAGR of 4.79%.
Meanwhile, the number of properties they own grew from 2,270 to 4,944 from 2007-2016. That’s a rather large increase, and it has turned Realty Income into one of the largest triple net REITs on the planet.
So the relative profit growth is certainly much lower than the absolute revenue growth (which isn’t surprising given the nature of the business model), but near-5% FFO/share growth over the last decade is really nothing less than impressive.
But what about those monthly dividends, right?
Well, Realty Income has been increasing its dividend for 24 consecutive years – ever since being listed on the New York Stock Exchange in 1994.
Plus, as aforementioned, they have a history of increasing the dividend multiple times per year.
As such, it should be no surprise they’re featured on David Fish’s Dividend Champions, Contenders, and Challengers list. This document tracks hundreds of stocks that have increased their respective dividends for at least the last five consecutive years.
A monthly dividend that’s increasing in size every few months?
That’s pretty tough to beat.
The company has managed to increase its dividend by an average rate of 4.7% over the last 10 years, which is right in line with the FFO/share growth we see above.
That tells me that management is prudent with its dividend growth, managing to right-size its dividend increases in a consistent manner that is really admirable.
While that kind of dividend growth might not cause you to jump out of your seat, it’s certainly well in excess of inflation. That means your purchasing power should be steadily increasing year in and year out.
Moreover, the dividend growth is especially noteworthy when we consider that we’re pairing it with a current yield of 4.5%.
I don’t know about you, but collecting a monthly dividend that yields me 4.5% on an annual basis is already a good start. Knowing that it’s growing at over 4.5% on an annual basis, too, sure gets me excited.
But we don’t invest in where a company has been. We invest in where it’s going. Plus, we want to know that the dividend is sustainable and capable of continued payments and growth.
Well, the current dividend runs the company ~$2.54 per share, per year. And that’s against the $2.88 in FFO/share we see that the company posted for its last fiscal year. That’s a payout ratio below 90%, which is comfortable for a consistent REIT.
The current payout ratio and the company’s history of demonstrating reliability and prudence add up to a dividend that appears to be very safe.
The most recent quarter showed AFFO/share growth grew 6.9% YOY.
And CFRA, a professional analysis firm, believes Realty Income will be able to compound its FFO/share at an annual rate of 4% over the next three years.
As such, I see no reason why we can’t continue to expect 4%+ growth from the company’s dividend over the foreseeable future.
The balance sheet appears healthy. They have $6.4 billion in total liabilities against $13.2 billion in total assets. They have investment-grade credit ratings of Baa1/BBB+/BBB+.
You have to like the company’s growth profile and diversification.
So I discussed the growth in absolute properties. But they’ve got great diversification and tenant quality across those properties.
Some of their top 20 tenants based on percentage of total portfolio rental revenue include great companies in their own right, spread out across diverse industries. These include Walgreens Boots Alliance (WBA), FedEx Corp. (FDX), and AMC Entertainment Holdings Inc. (AMC).
When you invest in Realty Income, you’re essentially investing in both commercial real estate and a broad cross-section of the US economy at the same time. You’re gaining business/investment exposure to everything from pharmacies to fitness centers. The company’s property portfolio is exposed to 47 different industries.
Realty Income’s 5,000+ properties are also heavily diversified geographically – they’re spread out across 49 states (and Puerto Rico).
And the tenant occupancy remains remarkably high, at 98.3%.
An investment in Realty Income basically gives me the opportunity to profit in real estate – and on a grand scale at that. This is heavily diversified commercial real estate that I, as an individual, simply couldn’t replicate on my own.
Moreover, commercial real estate is far outside my circle of competence. I don’t know your schedule, interests, or strengths, but I have plenty of things I’d rather be doing in life than trying to go out there and compete with Realty Income by building my own commercial real estate portfolio from scratch.
The same, frankly, could be said for trying to build out a massive residential real estate portfolio.
I’d rather collect my monthly dividend with a smile, all while doing basically nothing for it.
And you can do the same!
Shares in the REIT are trading hands for a P/FFO ratio of 18.5, based on the midpoint of 2017 FFO/share guidance (as of Q3 2017).
That seems more or less in line with recent historical levels for this stock.
The sales multiple (a bit over 12 right now) isn’t too far away from the five-year average, while the company’s cash flow multiple is just a bit less than the three-year average.
And the five-year average yield of 4.7% is within striking distance of where it’s at right now.
So the first impression is that the stock is roughly fairly valued.
But we’ll take it a step further.
I valued shares using a dividend discount model analysis.
I factored in a 9% discount rate (to account for the high yield) and a long-term dividend growth rate of 4.5%.
That DGR is in line with the 10-year dividend growth rate, the 10-year FFO/share growth rate, and the forecast for near-term FFO/share growth. Looking at the payout ratio, I suspect dividend growth and FFO/share growth will roughly mirror each other moving forward, as they have over the last decade.
The DDM analysis gives me a fair value of $58.98, which would indicate the stock is potentially moderately undervalued right now.
Bottom line: Realty Income Corp. (O) offers an individual a great opportunity to invest in a diversified portfolio of commercial real estate with long-term leases already locked in. These high-value commercial properties and the underlying favorable leases provide investors a monthly dividend that has been increased for 24 consecutive years, which can be thought of as a monthly “rent check”, except one doesn’t have to do any of the hard work themselves. If you want to be a “landlord” without the associated usual headaches, this stock could be just what you’re looking for.
— Jason Fieber
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