Assessing the Future Strength of Dividend Star Realty Income or Signs of Impending Challenges?
Realty Income (1.99% yield) has traditionally been popular among income-focused investors thanks to its regular dividend payouts, high yield, and history of dividend increases. Its performance has remained consistent over time as a real estate investment trust (REIT).
However, concerns are rising due to the financial struggles and store closures faced by several of its tenants, such as pharmacies, convenience stores, and dollar stores. These industries are facing creditor pressure and store closures.
Let's delve deeper into Realty Income's recent quarterly report, the security of its dividend, and its strategies for handling struggling tenants.
A Predictable Quarter
Realty Income reported another stable quarter, albeit with investors' attention fixed on its pharmacy, convenience store, and dollar store tenants. These sectors are under stress, with companies grappling with credit problems and store closures.
Realty Income's management highlighted tenants who had recently filed for bankruptcy and the high recapture rates achieved. Regarding Red Lobster restaurants, they mentioned having 216 properties, nine of which were rejected in bankruptcy court, resulting in a 91% recapture rate. Similarly, they reported an 88% recapture rate with Rite Aid, which has recently emerged from bankruptcy.
Regarding Walgreens and its store closures, Realty Income stated that it had managed 13 lease renewals in the year, all of which were successful with a 100% recapture rate. Historically, they mentioned having over 100% recapture rates for lease renewals with CVS, Dollar Tree, and Family Dollar.
As of the end of the quarter, Dollar General and Walgreens contributed 3.3% each to its annualized rent, while Dollar Tree/Family Dollar was 3.1% and CVS was 1.2%.
Realty Income is exploring the creation of a private capital fund to capitalize on opportunities in various sectors, including retail, industrial, data centers, and gaming. This fund is expected to provide long-term stable capital and recurring management fees.
Turning to Realty Income's third-quarter results, its revenue jumped 28% to $1.33 billion, propelled by new properties acquired and new investments. Same-store rental revenue increased 0.2% in the quarter, while its occupancy rate was 98.7%. The quarter saw 170 lease renewals, all with a 105% recapture rate.
Realty Income's diversification strategy proved beneficial in the quarter, with retail same-store rental revenue decreasing 0.3%, while industrial same-store rental revenue increased 1.9% and gaming increased 1.7%. Other properties, including data centers, showed a 4.7% rise in same-store rental revenue.
The REIT invested $740 million into new properties in the quarter with a 7.4% weighted-average cash yield. It also sold 92 properties for $249 million in proceeds.
Its adjusted funds from operations (AFFO) per share, a measure of the REIT's cash flow from operations, rose 3% to $1.05.
Realty Income raised the lower end of its full-year AFFO guidance, now ranging from $4.17 to $4.21, an increase from its previous estimate of $4.15 to $4.21. It now plans to invest $3.5 billion in new properties, an increase from its previous expectation of $3 billion.
A Secure and Growing Dividend
Despite the current tenants' challenges, Realty Income's dividend remains secure and is expected to continue growing.
Realty Income boosted its dividend by 3% to $0.789 in the quarter, marking its 108th consecutive dividend increase. The dividend was well covered by the $1.05 in AFFO it generated in the quarter, leading to an AFFO payout ratio of 75.1%. This robust coverage provides ample room for future dividend increases.
Should You Buy the Stock?
Realty Income's stock is currently contending with both positive and negative factors. While the REIT is confident in recovering lost rents from store closures, the challenges facing Walgreens, CVS, Dollar General, and Dollar Tree/Family Dollar deserve attention, as they account for about 11% of its annualized contracted rent.
On the positive side, a lower interest rate environment should benefit the stock and the value of its properties. Realty Income's stock has underperformed despite steady results in recent years, primarily due to higher capitalization rates, causing commercial property valuations to decrease. However, with interest rates decreasing, capitalization rates are starting to decline, boosting commercial property values.
Overall, I believe the interest rate environment will have a significant impact on the stock in the coming years, as Realty Income has shown resilience in handling customer credit issues and store closures in the past. Its exploration of private funding also seems promising.
Despite the financial struggles and store closures of several tenants in the pharmacy, convenience store, and dollar store sectors, Realty Income's management has managed to achieve high recapture rates with tenants like Rite Aid and Walgreens, demonstrating its effectiveness in handling struggling tenants. This resilience, along with its diversification strategy and recent quarterly financial performance, indicates a secure and potentially growing investment opportunity in the real estate market for those interested in finance and money.
Realty Income's robust Q3 performance, marked by a 28% revenue increase, a 100% recapture rate for lease renewals with Walgreens, and a boosted lower end of full-year AFFO guidance, indicates a strong financial position. This, combined with its exploration of private capital funds in various sectors, makes it an attractive option for investors looking to diversify their portfolios and capitalize on opportunities in the retail, industrial, data centers, and gaming industries.
