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Realty Income Just Boosted Guidance. Is This a Golden Opportunity to Buy This 6% Yielding Stock?

In Business
June 08, 2024

Realty Income (NYSE: O) has long been a favorite among income-focused investors given its attractive yield and monthly dividend payout.

Nonetheless, the real estate investment trust (REIT) has had a tough several years, with its stock price down about 20% over the past five years. However, the company just increased its guidance for the year, perhaps indicating brighter days could be ahead.

Let’s look at why the stock has struggled, and if the increased forecast could be a sign of better days ahead for the REIT.

Recent struggles

Much of the struggles with Realty Income’s stock the past few years have been related to rising interest rates. The REIT owns a portfolio of largely freestanding properties rented by retailers that are resistant to recession and e-commerce, such as grocery stores and pharmacies. It has also expanded into industrial and gambling properties.

It also uses long-term triple net leases, in which its tenants are responsible for utilities, property taxes, and maintenance. This reduces the REIT’s exposure to any unexpected cost increases.

While its business model is solid, the underlying value of its properties has decreased as interest rates zoomed higher over the past few years. That’s because commercial real estate properties are generally valued based on capitalization (cap) rates, which is a property’s net operating income divided by its current value. As interest rates have gone up, so have cap rates.

Capitalization rates are like the opposite of a price-to-sales or price-to-earnings ratio: the lower the number, the more expensive the property. Capitalization rates increase when either 1) the income from a property increases or 2) the property value declines. Typically, in higher interest rate environments, property values decline because of higher debt costs. Therefore, higher cap rates.

While Realty Income hasn’t had to deal with too many operational issues, its properties bought at lower cap rates have lost value, which has impacted its stock price. The good news, however, is that interest rate hikes appear to be over, which should stabilize cap rates. Meanwhile, if the Fed starts cutting rates, cap rates could move lower and property values higher.

Person with shopping cart in front of store.

Image source: Getty Images

Increased forecast

From a property valuation perspective, the worst is likely behind Realty Income in this current rate environment. Meanwhile, the company continues to invest in new properties at higher cap rates.

As part of its announcement increasing the low end of its guidance, the REIT said it now planned to invest $3 billion in new properties, up from a prior outlook of $2 billion. The company cited an improved investment environment, particularly in Europe, as the reason for increasing its outlook. In the first quarter, the company saw better investment economics in Europe with an initial weighted average cash yield of 8.2% versus 7.8% overall.

Looking ahead, the company upped its forecast on adjusted funds from operations (AFFO) to a range of $4.15 to $4.21 per share, versus prior guidance of $4.13 to $4.21 per share. The REIT continues to expect same-store rent growth of about 1% and for occupancy to be over 98%. It said it sees a continued stable outlook in its business overall.

Is it time to buy the stock?

With Realty Income’s AFFO projected to be around $4.20 based on company guidance and a forward dividend payout of about $3.15, its dividend is well covered and has room to grow. Meanwhile, capitalization rates appear to have stabilized and could move lower if the Fed cuts interest rates over the next few years, which would be good for Realty Income’s property values and thus its stock.

Operationally, Realty Income’s business looks pretty stable, despite some potential customer bankruptcy issues with Red Lobster, which represents 1.1% of its contracted rent. The raised guidance speaks to how the company is dealing with these issues and how its overall portfolio is performing.

Taken altogether, now looks to be a golden opportunity to buy the stock ahead of what should be a nice turnaround over the next few years as interest rates and cap rates ease.

Should you invest $1,000 in Realty Income right now?

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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Realty Income. The Motley Fool has a disclosure policy.

Realty Income Just Boosted Guidance. Is This a Golden Opportunity to Buy This 6% Yielding Stock? was originally published by The Motley Fool

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