Considering its relatively anonymous name and underlying business you might be surprised at the amount of time that gets dedicated to Realty Income (NYSE:O) on Seeking Alpha. By my count there have been a total of sixteen articles on the REIT since the start of March; an average of one of every couple of days. Why so much screen space for a seemingly boring real estate company? In a word: Yield.
What draws folks to Realty Income is fourfold. Firstly, ever since the company was founded in the late-1960s it has been pumping out rental dividends to shareholders. It establishes commercial property, lets them out on long-term leases and then mails the dividends to shareholders. Tenants pay all costs related to property management such as maintenance, property taxes and insurance. There’s not much more to it than that really. Around 25% of Realty Income’s portfolio on a revenue basis comes from Walgreens, FedEx, Dollar General, CVS Pharmacy, Walmart and Home Depot. They tend to be the kinds of retailers that are more immune to the online shift than most and so the cash flows are stable.
The slight twist is that Realty Income sends its dividends out on a monthly basis. In fact it has done so ever since it was founded. It even trademarked the slogan, “The Monthly Dividend Company”, just to hammer home how much it takes this point seriously. Needles to say, in an era which has got many folks hunting for regular and reliable cash streams that is going to stick out.
The brief breakdown of Realty Income’s dividend history is as follows: nearly 50 years of consecutive payments (over $4.5 billion in total), 78 consecutive quarterly increases and over 90 increases in total since it listed on the NYSE in 1994. Since its founding in 1969 it has clocked up approximately 570 consecutive monthly dividend payments. It goes without saying that it takes the distribution pretty darn seriously.
(Source: Realty Income)
Now at this point you may be looking at that 4.7% annual growth figure and be thinking “so what?”. After all it’s only a couple of points ahead of inflation. Pretty mediocre right? Actually this leads on to second reason why folks like Realty Income stock: the perpetually high yield.
If you go over the historical data stretching back to the 1994 listing you’ll find that Realty Income’s average dividend yield has been around 6.85%. When you’re looking at such a high starting yield it doesn’t take much growth in order to shift the needle toward serious long-term returns. Think Royal Dutch Shell, which was one of the best performing stocks of the second half of the twentieth century precisely because of its high yield and ultimately stable dividends (despite operating in a highly cyclical sector it hasn’t cut the dividend since the second world war, yet). To cut a long story short you can summarize that as follows: modest growth, spectacular long-term returns. If we come back to Realty Income we’ll find it’s a similar situation. That 4.7% growth rate looks pretty juicy when you add it to a stable 6.85% starting yield.
This brings us to third reason that folks like to discuss Realty Income: the historical returns. Had you purchased 1,000 shares of stock back in 1994 you’d have paid about $8,000. By the end of 2016 that would have grown to a value of $57,480 with a further $33,000 paid out in cash dividends. That’s works out as 11% annual returns over a twenty year stretch without factoring in the effect of dividend reinvestment.
Speaking of dividend reinvestment leads us into the fourth and final point: the income growth of high yield compounding. Let’s say that back in 1994 you set up the Direct Stock Purchase Program for Realty Income stock, currently administered by Wells Fargo. Let’s also assume your initial outlay was $8,000 for 1,000 shares as per above. In the first year you would’ve been looking at $900 in dividend income due a starting yield of around 11%.
Being part of a low cost DRIP programme you decide that you are able to defer that income for a couple of decades. Years of reinvesting high yields combined with modest growth and value multiple expansion see the value of your initial $8,000 worth of stock rise to well over $250,000 by end of 2016; equivalent to annual returns of almost 17%. On the income side of things that initial $900 per annum in dividend income is now worth something like $11,000 per annum. After stripping out inflation that’s equivalent to real annual growth of over 9%.
Okay so the four points listed above are probably enough to get the gist here. The short version is that consistently high yields that prove to be sustainable can generate great long-term outcomes with only modest growth. If you combine that with a long-term deflating dividend yield (i.e. an expanding valuation multiple) they become spectacular. This is why Realty Income is much featured on financial media sites like Seeking Alpha. But what about the current investment case? Let’s take a brief look at the long-term outlook.
Realty Income: Overvalued Right Now?
This is the crux of the debate right now with Realty Income stock. As I type it is currently yielding around 4.2%. If you pull up the relevant data you’ll see how low that is in historical terms. As far as I can tell Realty Income has never closed a year out with a lower dividend yield than the current value. Since the dividend accounts for such a huge chunk of total returns that’s quite a significant point worth bearing in mind. The short to medium term danger is a reversion to its historical average eating into forward returns.
This isn’t a siren call to sell a stock that’s been throwing off cash for the past fifty years. It’s also important to appreciate the low rate world we’re in right now: interest rates and bond yields have collapsed since Realty first listed in the mid-Nineties. This has partly driven the incredible total returns to date, but may work against investors going forward. If you’re on the outside looking in then now is probably not the time to buy Realty Income stock. Its sensitivity to a changing rate environment is pretty clear, and there will almost certainly be more attractive opportunities in the future. If you already own it then I imagine you won’t much care. Just kick back and enjoy what’s probably a pretty substantial yield on cost.