Investors worry that Realty Income has some troubled tenants, but it’s not as big a deal as it may appear.
An increasing number of retailers have fallen on hard times in some way. The list includes Rite Aid, Red Lobster, Walgreens (WBA 0.34%), Dollar Tree (DLTR -2.88%)At Home, and Big Lots (BIG 9.12%). For landlords, the problems here — from outright bankruptcies to plans to close underperforming stores — mean lost rent.
Realty Income (O 0.11%) is no different from any other landlord in this regard. But even though it has exposure to all the retailers noted above, it should sail through the rent problem without skipping a beat. Here are three key facts you need to know to understand why this real estate investment trust (REIT) is so well positioned.
1. Realty Income is an industry giant
Realty Income is the largest net lease REIT. Net leases require tenants to pay for most property-level operating costs. Net lease properties are generally only rented out to one tenant, so each individual property is a pretty big risk. Not only would a vacancy leave the property without any tenant in it, but the property’s upkeep might have declined if that tenant was in a weak financial state. There’s good reason for investors to have concerns about troubled tenants within the net lease framework.
Image source: Getty Images.
The risks of the net lease model, however, are diminished as a portfolio increases in size. The logic is simple: No single property is as important to the top and bottom line when the portfolio is big. Realty Income owns more than 15,400 properties. It is by far the largest net lease REIT you can buy and is roughly four times as large as its next closest peer by market cap. As for lessees, Realty Income serves more than 1,550 different tenants.
No single property or tenant is make-or-break for Realty Income. To be fair, some of the REIT’s largest tenants are the ones facing headwinds right now, including Walgreens and Dollar Tree, both of which are looking to potentially shut locations. But this is where point No. 2 comes in.
2. Realty Income has good properties
Although Realty Income is very large, that doesn’t mean it has opted to grow at the expense of quality. It specifically wants to own good locations, especially in the retail space, where the value is largely in the property’s location, not in the building on the property. Good locations tend to be leased again fairly quickly when there is a vacancy and are often the ones that are kept through a restructuring or location culling move. It’s a simplification, but “location, location, location” is a truism.
Realty Income has a large number of attractive properties. To highlight this with numbers, in the second quarter of 2024 the company had 199 leases renew. The rent on the new leases was 105.7% of the expiring leases, and the portfolio is 98.8% leased. Taken together, these two statistics speak to a company that isn’t having any problem with the quality and demand of its property portfolio.
3. History suggests Realty Income will sail through this
Still, Realty Income has troubled tenants that might leave it with some vacant properties. Here’s the thing: Realty Income has been around for decades and dealt successfully with the same issue throughout that span. Its dividend has increased annually for 29 consecutive years, including right through the Great Recession. So there’s plenty of history to go on.
Based on historical events (including the ability to sell assets, release them, or keep an existing tenant in place), Realty Income estimates that it will see a negative impact of around $0.02 per share of annual adjusted funds from operations (FFO) from the problem tenants in its portfolio today. Adjusted FFO in Q2 was $1.06. That was up 6% over the prior year. Do that math — in Q2 2023, the company earned roughly $1.00 per share. So in a single quarter, it more than made up for the FFO effect it expects from the at-risk tenants currently in its portfolio. Simply put, this issue isn’t that big a deal.
Realty Income is a “sleep well at night” REIT
Realty Income has trademarked the nickname “The Monthly Dividend Company.” That’s pretty bold, and everything management does is in service of remaining a conservative and reliable dividend stock. That includes dealing with the inevitable impact of troubled tenants. Yes, Realty Income has exposure to troubled tenants like Red Lobster and Walgreens. No, these issues aren’t going to be a big problem.
