Better Buy After Q4 Results: Realty Income Or Spirit Realty

Summary

• O and SRC are high-yield triple net lease REITs with investment-grade credit ratings.
• Both recently reported Q4 results.
• We review their Q4 results and then compare them side by side and offer our take on which is a better buy at the moment.
• Looking for a portfolio of ideas like this one? Members of High Yield Investor get exclusive access to our subscriber-only portfolios. Learn More »

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Both Realty Income (NYSE:O) and Spirit Realty Capital (NYSE:SRC) are high-yield triple net lease REITs with investment grade credit ratings. Both also recently reported Q4 results.

In this article, we review their Q4 results and then compare them side by side and offer our take on which is a better buy at the moment.

Realty Income Vs. Spirit Realty Capital: Q4 Results

O reported a strong 2022, with a 9.2% increase in AFFO per share for the year, driven by major acquisitions made in recent years. These include the VEREIT merger, the $1.7 billion casino acquisition, and the nearly billion-dollar purchase of a 185-property portfolio from CIM Real Estate.

However, the company's rent hikes are expected to remain below average in the net lease sector, with same property rents projected to rise by just 1.25% in 2023, despite facing high inflation. Realty Income is becoming increasingly dependent on new property acquisitions to drive growth, but this is getting harder as the company has grown larger and investment spreads have decreased.

The company expects a much smaller investment volume in 2023, with fewer accretive deals available due to the rising cost of capital. Realty Income has recently raised debt at a ~5% interest rate, which is lower than the 5-6% cap rate on its new acquisitions. This may force the company to seek higher yields in property sectors with which it is less familiar.

Meanwhile, SRC reported fourth quarter AFFO per share of $0.88, which fell short of the $0.91 average analyst estimate but still increased from $0.85 in the same period last year. The occupancy rate remained high at 99.9%, with only 0.1% loss in rent and 1.4% in unreimbursed property costs.

In the quarter ending December 31, 2022, the company invested $350.8 million at a cash capitalization rate of 7.15%, including the acquisition of 24 properties through 16 transactions with a weighted average lease term of 15.6 years. Additionally, it generated $134.8 million in gross proceeds from the sale of 27 properties, 21 of which were occupied, at a disposition capitalization rate of 6.22%.

SRC has provided guidance for its AFFO per share for 2023, expecting it to be in the range of $3.53-$3.59, which is lower than the consensus estimate of $3.74. The company plans to allocate $700M-$900M in capital for acquisitions and revenue-producing expenditures. It also expects dispositions to range between $225M-$275M.

Realty Income Vs. Spirit Realty Capital: Business Model

Both O and SRC have low-risk business models, as they primarily lease out diversified portfolios of single-tenant real estate on long-term triple net leases to a wide variety of tenants across various industries. This has resulted in stable cash flows for both companies, regardless of the business environment.

In terms of scale, O is much larger with 12,237 properties leased to 1,240 tenants. On the other hand, SRC is much smaller as it leases out 2,115 properties to 351 tenants. However, the diversification of both portfolios is sufficient to maintain a low risk profile in the event that any of its tenants face challenges.

SRC has a longer weighted average lease term of 10.4 years compared to O's 9.5 years, but O generates a higher proportion of its rent from investment grade tenants (41% compared to SRC's 19.5%). Despite this, both companies' portfolios performed well during the COVID-19 pandemic, demonstrating the strength of their counterparties.

SRC has a greater exposure to industrial real estate (23% compared to O's 13.3%), which generally enjoys stronger rental growth and demand than retail. Furthermore, SRC is increasing its allocation to industrial assets, with 41% of its acquisition spending in the past twelve months going towards this sector.

Realty Income Vs. Spirit Realty Capital: Balance Sheet

Both REITs have strong balance sheets, with O having an A- credit rating and SRC having a solid BBB credit rating.

SRC's debt has a 6.4-year weighted average term to maturity compared to O's 6.2-year weighted average term to maturity on their respective notes and bonds. Furthermore, SRC has a fixed charge coverage ratio of 5.2x, while O's ratio is 5.2x. Additionally, SRC has no debt maturing in 2022-2024, with just a $301 million term loan maturing in 2025. In contrast, O has a meaningful amount of debt maturing every year for the foreseeable future.

SRC's debt is 99.9% unsecured compared to O's 95% unsecured debt. Finally, 98% of SRC's debt is at fixed interest rates, whereas O has only 85% of its debt at fixed interest rates. Overall, while O has certain financial advantages over SRC, largely stemming from its superior scale, SRC's balance sheet holds its own quite well compared to O's and is well-positioned to handle the current economic environment, including the rising interest rates and a potential recession.

Realty Income Vs. Spirit Realty Capital: Track Record

O clearly outperforms SRC in terms of its track record, which is one of the strongest arguments for investing in O instead of SRC. O has grown its dividend per share for 27 consecutive years, making it a member of the exclusive Dividend Aristocrats group. Additionally, O pays out a monthly dividend, which is more attractive to many retirees than the quarterly dividend that SRC and most other companies pay. Furthermore, O has delivered exceptional long-term performance:

Data by YCharts

Moreover, O has outperformed SRC since SRC went public, but just slightly:

Data by YCharts

Still, SRC's performance has not been terrible as it has massively outperformed the broader REIT sector (VNQ) since going public:

Data by YCharts

Realty Income Vs. Spirit Realty Capital: Valuation

When comparing these REITs side-by-side, we see that SRC is convincingly cheaper than O on virtually every valuation metric:

Valuation Metric	SRC	O
EV/EBITDA	13.68x	17.51x
EV/EBITDA (5-Yr Average)	15.14x	19.41x
P/AFFO	11.41x	16.07x
P/AFFO (5-Yr Average)	12.80x	18.53x
Dividend Yield	6.5%	4.8%
P/NAV	0.98x	1.18x
P/NAV (Historical Average)	0.98x	1.14x

Click to enlarge

Although some investors may prefer O over SRC due to its slightly higher expected AFFO per share compound annual growth rate over the next few years, this advantage is solely due to its higher P/NAV ratio. However, this benefit is offset by the significantly higher dividend yield and AFFO yield that investors can receive by investing in SRC today. Moreover, given SRC's lower exposure to floating rate debt and lack of debt maturities over the next several years in contrast to O's maturities in each year moving forward, we think that SRC may actually outperform its current analyst expectations whereas O may underperform. Consequently, it appears that SRC is poised to deliver substantially better total returns in the future, even without accounting for the possibility of future P/NAV multiple expansion.

Investor Takeaway

Investors who value a strong track record and credit rating may find that O is the superior choice between the two REITs.

However, SRC's track record for total returns since going public is only slightly behind O's, and much of that difference can be attributed to valuation multiples rather than underlying value creation. Additionally, the failures of SRC's old business model before its shift to a pure-play triple net lease structure contribute to this performance gap.

Overall, despite having a portfolio and balance sheet that are not significantly weaker than O's, SRC has the potential for stronger total returns. Therefore, we believe that SRC currently offers the best risk-reward ratio between these two REITs.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in SRC over 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.

Comments

[jack kreg]

Spirit is serious buy in mid 30's
its getting close, todays close at $37.60
Wondering if TH open will be strong down, todays close was weak!!

[brazbtms]

Own Both! So no problem. But O would be the last one I would part with.

[Zucks]

Bought SRC as a replacement for STOR which I was forced to sell for the 20% Assuming a declining market though, O at say 5%!will be very attractive. No purchases till after the Fed meeting though, too risky. Informative article, thanks.

[Samuel Smith]

@Zucks you're welcome

[Bucknfl]

Both are holds.

[Samuel Smith]

@Bucknfl thanks for sharing

[birder]

I own them both but about 50% more O than SRC. But SRC pays a lot higher dividend than O.

[Samuel Smith]

@birder true

[mdpath]

I think it would have been interesting to have included EPRT in the discussion as it too is a triple net lease and similar to SRC.

[Samuel Smith]

@mdpath we have discussed it in past articles, possibly future ones as well.

[Steve Rasher]

@Samuel Smith Thanks for another excellent article. I have read other positive articles on $SRC, but I have always been leery because of their early issues. But your article has really piqued my interest. The section on business models was quite interesting to see that $SRC has a greater percent of its portfolio in industrial sites and that it is growing that line of their portfolio. But the one that really hit home was the section on the balance sheet and related metrics; $SRC has really solidified its balance sheet, and I like the fact that it has little debt coming due over the next few years ($O on the other hand has some coming due each of the next few years). I was pleasantly surprised to see that 98% of their debt is fixed and that 99% is unsecured. Now, I already have a sizable position in $O that I intend to continue to hold. On the other hand, in my Roth I have a REIT that has become a battle ground stock and, although I am somewhat positive on it, it is now providing a little to much drama, and $SRC looks like the kind of stock I might want to replace it with, even if I do give up a bit of yield. Thanks again for the article. Steve

[Samuel Smith]

@Steve Rasher you're welcome! Glad it was helpful.

[Income4ever aka Cyclenut]

@Steve Rasher
MPW is definitely giving us drama and I'm looking to exit for same reason ... too many other quality opportunities abound...
I'll use proceeds to add to my SPG position

[Steve Rasher]

@Samuel Smith Also saw @Gen Alpha article today and did my due diligence. As a result bought a nice position in $SRC today. Steve

[usiah]

Just added more O today. (No SRC position.)

Retired income investor

[Samuel Smith]

@usiah thanks for sharing.

[wam350]

@usiah
Likewise

[RayRay1000]

Party City, theatres, casual dining, club corp, At Home and enough crappy fried chicken franchises in south Texas to clog the arteries of SA’s roster of authors and SRC is the equivalent of O? Oh, and declining FFO from ‘22 to ‘23. I’ll have one of whatever he’s having please.

[Zucks]

@RayRay1000
Having done work in Texas, those BBQs and chicken places are great places. Recommended.

[RayRay1000]

@Zucks good chicken, crappy credit. In the QSR sphere, they are the bottom of the barrel.

[robkrow]

Good coverage. Thanks.

[Samuel Smith]

@robkrow you're welcome

[Jimmy_Newyork]

Why did you leave out the dividend discussion? Probably up there with what most people would be looking for in a talk about net lease REIT's... Compare the dividend growth, compare the dividend coverage, compare the dividend history and safety... Great article but missed one of the key points

[Samuel Smith]

@Jimmy_Newyork we have discussed this in past articles. I appreciate the feedback and will keep it in mind moving forward.

[Income4ever aka Cyclenut]

O is high yield... honestly not in my book...
My core account money market yields about the same
Os appeal is suffering due to rather low dividend
Cheers

[Samuel Smith]

@Income4ever aka Cyclenut thanks for sharing

[RayRay1000]

@Income4ever aka Cyclenut all REIT prices are depressed because of higher interest rates. If Sam Smith listened to either O's or SRC's earnings call he would have discovered that while Jackson Hsieh is concerned about his cost of capital relative to his peers and has only moved into industrial and OIS in particular due to more favorable spreads (he can't compete with O, ADC or WPC for the best retail properties) Sumit Roy can tap into a war chest which will be deployed for acquisitions in one of the most favorable buy side environments in years.

[Income4ever aka Cyclenut]

@RayRay1000
Absolutely agree ... my only point was O is not high yield

[sickkat3]

I know we'll hear this many times, but let me be first to say...I own both. And hope that someday O buys SRC.

[Samuel Smith]

@sickkat3 nice

[Alaric]

@sickkat3 same here. O buying SRC in an all stock deal is a no brained. I can’t think of a better acquisition target since they bought VER.

[Income4ever aka Cyclenut]

@Alaric
Looks like O is interested in further diversification away from its core and SRC is just more of the same... first it was gaming, then farming and they also have sights on industrial....
Time will tell