- Same store rent was up 1.1% year on year,
- Revenue up over 60% on the acquisition,
- The company saw unprecedented supply of properties put on the market this quarter and finally,
- Diversification and improvement of tenant quality continued.
Realty Income is a Real Estate Investment Trust. They acquire and own freestanding retail properties which generate rental income from long-term leases, typically between ten and twenty years. Their agreements are triple net leases, which means that the tenant is responsible for property taxes, insurance and maintenance. Realty is large by REIT standards, with a broadly diversified portfolio of over 2,600 properties. This article will cover some of the important takeaways from this quarter.
Business As Usual
Realty Income is progressing on all of its major goals while modestly increasing revenues, Adjusted Funds From Operations (AFFO) and also dividends. Revenue has grown year-on-year while expenses have been moderate. Occupancy has gone up 90 basis points from last year at this time, rising to 98.2%. AFFO increased 18% from the year ago quarter, largely again due to their ARCT acquisition.
A Flood Of Supply
Management saw $15 billion in retail properties that they believe may fit well into Realty's portfolio, the most they have ever seen. This compares to the $5 billion management saw just a few years ago. Management believes that the rest of this year will have plenty supply, but not as much as this particular quarter. Because management is trying to improve the credit quality and cash flow safety of its tenants across the board, they have indicated that they will "pass up" most of these deals. So, the new supply may not translate into heightened acquisition activity.
It is also worth mentioning that of this new supply, Capitalization Rates, which is yearly income / total value, have risen sharply along with interest rates in general. Management was surprised by this, as "cap rate" hikes historically lag interest rate jumps and don't move in tandem like this.
Realty Income has been making a concerted effort over the last few years to increase its pool of tenants, so as not to rely too heavily on a single one. That process was evident in this quarter. Their top 15 tenants went from 53% of revenue down to 43.5%. Their single largest industry, convenience stores, came down to 11.4% of revenues from 16.9% a year ago. Restaurants came down to 9.9% from 13.8% a year ago.
Maybe the most interesting takeaway from this call is how well management is moving Realty to a safer tenant base. Two years ago management put together a system of grading tenants based on credit quality, safety of cash flow and exposure to areas they deemed favorable and unfavorable in a situation of higher rates. They divided them into four color codes: Green for a strong buy, yellow for a buy, red for hold and black for sell.
Two years ago when this started, their tenant profile looked like this:
- Green: 22.8%
- Yellow: 21.4%
- Red: 15.9%
- Black: 22.9%
As of the this quarter, their profile now looks like this:
- Green: 45.1%
- Yellow: 18.4%
- Red: 15.8%
- Black: 8.8%
By concentrating on retail stores for higher income customers (or at least low income stores with great value propositions), favoring investment grade tenants and those with stronger cash flows, Realty has moved from black to green. Rising interest rates strike fear into the hearts of many investors. How much exposure does your portfolio have? How will the business we own be effected? Realty Income group has been preparing for two years now.
Realty has made good progress this quarter. They have stayed disciplined with acquisitions, refusing to grow just for growing's sake. They have increased occupancy rates and grown same-store rent. They have diversified their tenant base while moving to higher ground for the days when interest rates are higher. Most of all, they are optimistic in their ability to continue increasing dividends in the future.