- 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.
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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:
Moreover, O has outperformed SRC since SRC went public, but just slightly:
Still, SRC's performance has not been terrible as it has massively outperformed the broader REIT sector (VNQ) since going public:
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:
|EV/EBITDA (5-Yr Average)||15.14x||19.41x|
|P/AFFO (5-Yr Average)||12.80x||18.53x|
|P/NAV (Historical Average)||0.98x||1.14x|
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.
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.
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This article was written by
Samuel Smith is Vice President of Leonberg Capital, he has a diverse background that includes being lead analyst at several highly regarded dividend stock research firms. He is a Professional Engineer and Project Management Professional and holds a B.S. in Civil Engineering & Mathematics from the United States Military Academy at West Point and has a Masters in Engineering.Samuel leads the investing group High Yield Investor investing group. Samuel teams up with Jussi Askola and Paul R. Drake where they focus on finding the right balance between safety, growth, yield, and value. High Yield Investor offers real-money core, retirement, and international portfolios. The services also features regular trade alert, educational content, and an active chat room of like minded investors. Learn more.
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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.