Solving investing puzzles becomes fun when you reverse engineer what has happened historically with a particular stock and then make educated guesses about whether the fertile soil still exists to replicate the past successes that led to satisfactory returns. In the case of Realty Income (NYSE:O), the history has been this: over the past nine years, investors that dutifully collected their monthly Realty Income dividends and reinvested along the way would now be collecting a 14% annual dividend based on the amount of capital that they initially invested.
For someone looking to set aside capital in Realty Income today that would lead to similar results going forward, it is worthwhile to ask: What conditions were necessary for Realty Income to deliver that 14% annual yield-on-cost relative to the amount invested over the past nine years, and do similar conditions exist today?
Here's how the comparison looks like: nine years ago, Realty Income investors could get an initial dividend yield somewhere between 5% and 6%. Today, you can get an initial yield with Realty Income slightly above the 5% mark. Over the past nine years, Realty Income has grown its dividend by a 5.47% annual compounded clip, while growing its funds from operations at a 4.17% annual clip.
The question we have to answer, then, is whether it seems that Realty Income can grow by, say, at least 6% (to offset the fact that investors today have a slightly lower yield than those of nine years ago) to replicate over the coming nine years what it has done over the past nine.
I think the answer is a tentative yes because Realty Income is currently doing two things that are unusual for a real estate investment trust: it is growing rapidly, and it is doing so in a high quality way. You can look to the effects of the American Realty Capital Trust acquisition and other 2013 moves to see how Realty Income is both rapidly expanding and simultaneously improving its quality.
To speak specifically: Realty Income purchased 450-500 properties for a cost of $1.5 billion while also spending a bit over $3.0 billion to acquire the 500+ properties in the American Realty Capital Trust portfolio. The senior debt, although it increased from $2.7 billion to slightly below $4.0 billion, was more than offset by the fact that Realty Income witnessed a total increase in permanent revenues of 65% due to the firm's 2013 acquisitions. While other real estate investment trusts have been cavalier about taking meaningful strides towards immediate growth due to the prospect of rising interest rates, Realty Income has plowed ahead by increasing its funds from operations 19.39% from $1.96 in 2012 to $2.34 by the end of 2013.
Most impressively, though, Realty Income has been able to execute its expansionary plans without lowering the quality of the tenant-customer base. Before Realty Income kicked off its rapid set of acquisitions in 2013, the firm had an occupancy rate of 97%. Given the fact that Realty Income has acquired almost 1,000 properties in the past year, it would be fair to wonder whether the firm overreached and lowered its overall quality to expand its real estate footprint.
That hasn't been the case - Realty Income looks more diversified and full of occupants than ever. It has almost 3,900 properties under its belt across 49 states that now sport an occupancy rate somewhere between 98% and 98.5%. In other words, Realty Income grew its revenues by 60%, but did it in a sustainable fashion because the portfolio of properties now contains more rent-paying tenants than it did before the series of 2013 acquisitions. And the debt-to-equity ratio is only at 0.77 to 1. The rapid growth did not destroy the balance sheet nor did it lower the quality of Realty Income's tenant base, and that should be welcome news for those that intend to hold Realty Income for the long haul.
It seems entirely plausible that Realty Income investors could average 6% annual dividend increases over the coming nine years because the company also has the ability to start raising rents by more significant figures than in years past. Coming through the Great Recession, rents had been slow to increase at a lot of Realty Income properties because we were at a low point in the real estate finance business cycle; last year, Realty Income was only able to raise rents collectively by a bit over 1%. That's about to change; rents will be increasing by 3% or 4%, and the company has the credit reserves set aside for over $1 billion in new acquisitions over the coming year. The combination of new acquisitions and rental increases should give Realty Income investors a long-run dividend growth rate in the vicinity of 6% annualized.
Even though Realty Income is a much bigger company today than it was nine years ago, it seems to have the same circumstances in place for this to be a case where the past truly is the prologue of what is to come. People who have bought and held Realty Income for the past nine years are now collecting $0.14 annually on every dollar they invested. That success should be replicated over the coming nine years as well; occupancy rates have increased from 96% in 2011 to over 98% today, the company has $1 billion earmarked for immediate acquisitions, and the anemic 1% rental increases in years past are set to turn. For those that look to earn high future annual dividends on the money they set aside today, Realty Income appears poised to uphold the high standards they have set for investors over the past nine years.
Disclosure: The author is long O. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.