Strong Dividends, Strong FFO Growth, Mediocre Revenue Growth: The Story Of Realty Income

Summary

• A strong history of raising dividends makes Realty Income Corporation a preferred holding for many investors.
• While rental rates are only rising by around 1.4%, the REIT keeps increasing FFO and AFFO.
• Because they trade at favorable valuations, they have the option to use the equity market to finance new assets that generate more than enough income.

Realty Income Corporation (NYSE:O) has an incredible track record that should put it on the radar for any income investor. To be fair, perhaps it should be on the radar for all investors since the total returns have been so solid. I'm always looking for new and interesting companies to cover, so I spent Saturday learning about Realty Income Corporation. Often the discussion about these solid income names can end up either skipping the underlying business or becoming thoroughly entangled in accounting nuances. Of course, if you're following me you probably know how much time I spend dealing with accounting nuances in the mREIT sector to improve comparisons between mREITs.

A Simple Introduction

For investors who are not already familiar with Realty Income Corporation, I suggest a simple introduction that should help investors get a feel for how the company works, why they have been able to perform so well, and why they are an excellent candidate for dividend growth portfolios.

Big Dividend Power

This REIT has an incredible track record for paying dividends. Their emphasis on paying strong dividends month after month results in strong demand from shareholders. When interest rates are terribly low, having a quality source of reliable income is a very appealing aspect for many investors and after 540 consecutive monthly dividends have been paid, investors should feel that this company has earned some faith. Granted, investors should always diversify, but this looks like a solid way to build part of an income portfolio to sustain the investor who wants a respectable yield from a reliable REIT.

Earnings Guidance

The slide below contains management's estimates for FFO per share and AFFO per share:

There are some very important things investors should recognize on this slide. The projected growth in FFO and AFFO is quite substantial. Since dividends have grown at an annualized rate of 4.6% over two decades, it is reasonable to expect that FFO and AFFO also must be growing at a significant rate.

The irony for some investors may be that this growth rate relies on a very large volume of acquisitions and a fairly small growth rate for same store rents. This is not a REIT that's growing their FFO and AFFO by jacking up rental rates. This makes them very different from quite a few of the major apartment REITs that are growing their values by jacking up rents in cities that have very limited supply.

Rather than relying on jacking up rents, O is able to enhance their values through effectively utilizing debt and equity markets to get financing at rates lower than the return they expect on new investments. This is an intelligent way to utilize their standing in the market. They are an attractive REIT even if excepted returns were lower because they are so solid. They are establishing themselves as a less risky option for income which gives them a competitive advantage in financing properties.

Keeping the Portfolio Rolling

While the same store rent growth is only projected to be around 1.4% for the REIT, the properties that had expiring leases have so far all been renewed and those properties saw rental rate increases of 2.5% on a weighted average. In short, Realty Income Corporation is doing a great job of getting those properties rented out at attractive weights, dealing with one of the big risks for equity REITs - vacancy.

Disposing of Properties

This is going to be an interesting area to tackle. The REIT is heavily focused on acquiring new real estate and then holding the real estate. I'm a big fan of this strategy. Selling off profitable assets is a poor long-term strategy unless materially superior investment opportunities are available.

Conclusion

Realty Income Corporation has funded an incredible history of paying out increasing dividends by generating solid growth in their non-GAAP earnings metrics. This growth occurs even when the REIT is only seeing same-store rental growth rates average 1.4%. Simply put, this is a very solid performance and the REIT's long history of paying out increasing dividends gives it a real argument for being "best of breed" and demanding superior valuations. Using those valuations, the REIT can look to issue new shares because they have new investment opportunities that produce a high enough income level to keep their FFO per share growing.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.