Realty Income Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Realty Income is a diversified real estate investment trust (REIT) primarily focused on acquiring and managing freestanding, single-tenant commercial properties leased to clients, typically with long-term leases and a focus on reliable tenants.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Realty Income operates as a triple-net lease REIT, meaning its tenants are responsible for most property operating expenses like property taxes, insurance, and maintenance. This allows Realty Income to have a relatively stable and predictable cash flow with less operating risk.

Revenues for Realty Income are essentially all rental income from its vast and diversified portfolio. As of September 30, 2023, the REIT held 13,375 properties, with approximately 81.1% of their contractual rent coming from their top 20 industries, and nearly all these properties are retail based in that more than 78 percent of portfolio rental income comes from retail. This is a massive portfolio diversified across geographies, industries, and tenants.

Key aspects of Realty Income’s business:

  • Diversification: Geographically diversified portfolio, with a substantial footprint in the U.S., the U.K., and Spain. Also, a large portfolio of tenants across various industries.
  • Long-Term Leases: Long-term, triple-net leases with creditworthy clients.
  • Monthly Dividends: A focus on providing consistent monthly dividends to investors. This is a cornerstone of their brand and appeal to investors.
  • Internal Growth: Increasing same-store rent and re-leasing properties at higher rents than its previous rates.

The REIT sector faces several challenges and shifts. The shift towards e-commerce has hurt retail and mall-based REITs because of the decrease in in person retail sales. However, Realty Income has a different approach and focuses mostly on freestanding properties leased to big, well-established retail chains that are not prone to going online, at least not at the same scale. Other economic shifts like rising interest rates have posed a challenge to many REITs, due to the increase in the weighted cost of capital which could hurt acquisitions and returns, but, Realty Income is a well-established REIT which has a healthy balance sheet and access to various financial instruments, so these risks are not as impactful as it may be for others.

Financial Analysis

Realty Income’s recent quarterly results:

  • Q3 2023 total revenue increased to $1.085 billion, and operating revenue increased by 19.4% to $955.6 million, and net income attributable to common stock was $117 million, or $0.14 per share.
  • Q3 2023 FFO was $1.00 per share, an increase from $0.94 in the prior year.
  • The company has increased its annualized dividend rate to $3.077, which represents a 3.3% increase compared to the previous yearly dividend rate.
  • Lease revenue increased by 19.5% compared to the last year, primarily driven by acquisitions and contractual rent increases.
  • Same-store rental revenue increased by 1.9%.
  • Occupancy rate was 98.9%.

Realty Income’s financial stability is quite good. They are a well-run and experienced company in the REIT market. They generate a very solid and reliable source of income, being a triple-net lease REIT with a very big portfolio. The fact that they operate with long term agreements, further increases the reliability of the company. Also, their tenants are generally large chains and strong companies which increases the safety of the generated income.

However, their debt to assets ratio is quite high, at over 40% according to the last 10-K. However, as it is standard for REITs to operate with a higher level of debt, its something that, given their good performance, can be considered normal and acceptable.

The fact that most of their revenues are based on real estate properties, also makes their company more vulnerable to changes in the real estate markets. Also, Realty Income is extremely dependent on the health of their tenants. If most of their tenants are doing well, that’s a big boon, but if something goes wrong with the profitability of their tenants, then, they will have problems, so is important to consider and monitor the financial health of its clients and its industries.

Moat Assessment

Realty Income has a narrow moat, rating it at 3/5.

  • Realty Income has a competitive advantage due to its scale and wide diversification, which is difficult for any new player to fully emulate. However, there are many players in the real estate sector, and some are also highly profitable and similar to Realty Income, but Realty Income’s operational excellence does provide some advantage.
  • Their long-term leases provide some predictability of cash flows, but competitors also offer long term contracts, so this is not a big edge. However, the size and scale of their portfolio, does allow the company more leverage in pricing than other players.
  • Realty Income also has access to better financial backing because they are a well-known REIT with a solid track record of stability and high returns to investors. They have the possibility of borrowing at low rates that other competitors might not get.
  • They also enjoy an element of customer lock-in, meaning existing tenants are likely to stay in place, because their leases are tied to the building’s features and amenities, and that makes them less likely to move.
  • These advantages, put together, give them a narrow but still significant economic moat.

Risks

Several risks could affect Realty Income’s moat and financial performance:

  • Changes in the real estate market: Interest rates, market sentiment, changes in economic conditions can and do impact the price of their real estate, and it may greatly affect their margins. Also, if property values and rent revenues decrease due to changing trends, such as online retail, this would also significantly impact the REIT.
  • Reliance on a few major tenants: A failure of one or several of their key tenants, like a massive retail chain, could have an extreme impact on their profitability. And if a big tenant leaves, this will also hurt the perception of the business as well.
  • Changes in regulations: The government and other regulators could change policies, particularly regarding real estate management and rent control, making the business profitability decrease, depending on the change.
  • Inability to grow: Due to their size, it can be difficult for Realty Income to continue to generate substantial growth. Their large size limits their flexibility in new and smaller markets which may contain more profitability and growth, and the larger the REIT becomes the harder it is to find acquisitions that make a true significant contribution to their overall business.
  • Disruptive technologies: Disruption in technology such as a rise in virtual reality can have an impact on in-person activities, such as retail, that Realty Income is dependent on.

However, Realty Income is quite resilient in its business model. Firstly, their portfolio is extremely well diversified, and this helps to mitigate risks stemming from a single entity, region, or sector. Secondly, they have a management team which is experienced and has a track record of adapting to challenges. Thirdly, their long-term contracts provide a certain amount of flexibility because they will continue to receive income even in tough economic times. Fourthly, due to their size, they have a better ability to access credit and debt markets at low rates than smaller players.

Understandability

The business model of Realty Income is easy to understand, as a triple-net lease REIT. However, valuation is a bit more difficult, because it relies heavily on projections, as well as their lease agreements and the underlying health of their tenants. The REIT sector also is complex because of the accounting standards that it adheres to and the REIT model itself. Also, the complexity of the business model and the number of subsidiaries and properties makes it hard to truly understand the inner-workings. I’d rank their understandability at a 2/5.

Balance Sheet Health

Realty Income’s balance sheet health is also fairly good, rating it a 4/5:

  • They have more than $3 billion in available liquidity from a combination of cash, equity, and available credit facilities, ensuring a financial backup for difficult periods.
  • They have a somewhat elevated debt-to-assets ratio, but this is normal for large, well-established REITs and it is being well-managed. Their credit ratings are a testament to the financial strength and stability.
  • Their use of preferred stock and other complex financing also indicates some risk, because these financial structures make the company more sensible to the markets.
  • Their debt structure is well diversified across maturity dates, which helps to mitigate risks of rising interest rates in the near term.
  • Their debt maturity profile is mostly focused on the longer term, mitigating refinancing risks.
  • They also have a great ability to raise capital, whether through equity, long-term or short-term debt, due to their size and established position in the market, that some smaller players lack, giving them a financial advantage over other REITs.

They appear to be very stable, but they also must be very careful in the future.

Concerns and Management Outlook

There are many concerns about the overall state of the real estate market, and how it will be affected by different external forces such as interest rate hikes, inflation, and economic slowdown. In the latest earnings call, the management seems confident about the resilience of their business model and its long-term profitability, citing the long-term contracts, high occupancy and diversification. However, they do acknowledge that they are seeing an effect in the markets as fewer new deals are made, but the management team insists they are still a prime choice in the REIT market and will continue to provide a good return to its shareholders.

It appears to be a good business with a strong foothold in its sector. But if they mismanage future challenges or external factors impact them negatively, then their valuation could take a severe hit.