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This month's REIT Focus is on Realty Income Corporation (O), a publicly traded, self-managed real estate investment trust that primarily owns single tenant corporate, retail and restaurant properties. As of 9/30/12, O owned 2,838 properties comprising 34.3 million sq.ft. located in 49 states. O's tenants are primarily specialty retailers, drugstores and restaurants, and major tenants include AMC Theatres, LA Fitness, Diageo, BJ's Wholesale Club and Family Dollar stores. O's properties are leased to 144 different commercial enterprises in 44 different industries. The average occupancy of O's portfolio as of 9/30/12 was 97%. O was incorporated in the State of Maryland, became public in 1994 and is based in Escondido, CA.

In the third quarter of this year, O announced an agreement to acquire all of the outstanding shares of American Realty Capital Trust (ARCT), a publicly traded net lease REIT, in a transaction valued at approximately $2.95 billion. The Board of Directors of both companies have unanimously approved the agreement and the transaction is expected to close in the fourth quarter of 2012. The purchase price of ARCT equates to a capitalization rate of approximately 6%, which we consider way too low and the acquisition will be negative to O.

O has 132 million shares outstanding and a market capitalization of $5 billion. O's management team includes Tom Lewis, Chief Executive Officer and Vice Chairman of the Board of Directors, who has been with the company since 1987 and Gary Malino, President and Chief Operating Officer, who has been with the company since 1985.

Select financial data for O as of the 9/30/12 10Q and for the period 1/1-9/30/12 is as follows (in millions where applicable):

Real Estate Assets, Gross$5,629
Total Assets$5,036
Mortgages, Notes Payable and Lines of Credit$2,492
Stockholders' Equity$2,443
Net Income$120
Earnings Per Share$.65
Cash Flow from Operations$208
Unsecured Credit Facility ($1 billion with $609 million used)$391
Market Capitalization$5,000
Debt to:
Gross Real Estate Assets44%
Market Capitalization50%
Real Estate Assets Per Sq. Ft.$164
Dividend Yield ($1.82/sh.)4.8%
NOI and Value Calculation:
Revenue Per Above Annualized$467
Less: Operating Expenses$47
Projected NOI 2012$420
Projected Inflation Ratex103.5%
Projected NOI for Next Year$435
Projected Cap Rate7.5%
Projected Value of Company$5,800
Less: Total Debt and Preferred Stock($3,101)
Projected Value of Company Equity$2,699
Shares Outstanding132
Projected Value Per Share$20
Current Market Price Per Share$37

As shown above, our value for O is $20 per share versus a market price of $37 per share. Current cap rates for net leased retail properties per CBRE and Real Capital Analytics investment surveys are in the 6% to 9% range, depending on the credit of the tenant and location of the property. We have used a cap rate of 7.5% due to O's portfolio being primarily single tenant leases with non-investment grade tenants. At a price of $37 per share, O is trading at a cap rate of 5.5% which we believe is too low of a valuation for a net lease REIT with this type of portfolio.

O's gross real estate assets, net income and funds from operations for 2010 to 9/30/12 are shown below.

(millions)201020119/30/12 (9mos)
Gross Real Estate Assets$4,113$4,972$5,629
Net Income$106$133$120
Funds from Operations$193$249$189

A five-year price chart of O is shown below:

(click to enlarge)

O's strengths include: well managed company, diversified portfolio of net leased assets, attractive dividend yield of 4.8% and low leverage at 44% of assets, and weaknesses include: portfolio is highly correlated to economic growth and interest rates, the stock is richly priced and overpaying for the ARCT acquisition. O is a solid net lease REIT with an attractive dividend, however, we do not recommend purchasing the stock at this price.

Source: REIT Focus: Realty Income Corporation