Is Realty Income a Dividend Cultivator REIT?

If you follow dividend investing and REITs in particular, one name will almost always pop up as a solid dividend payer: Realty Income $O. Rightly so! Realty Income pays monthly dividends and has raised its dividend for the last 26 years. But is it a right fit for someone looking to grow dividends aggressively?

Let’s look at our criteria:

  1. High Quality
  2. High Yield
  3. High Dividend Growth

High Quality

Our proxy for high quality is credit rating and Realty Income passes this bar quite well. Realty Income’s credit rating is A3 at the time of writing, well into investment grade. Moody’s issued the following rationale for their upgrade:

The A3 rating is also supported by the strength of Realty Income’s balance sheet which is underpinned by its limited use of secured funding, and modest overall leverage as measured by effective leverage and net debt to EBITDA. As of the end of 3Q17, the company’s effective leverage was 36.3%, down from 41% at YE2016. Net Debt to EBITDA was 5.4x for the same period, down from 5.9x at YE2016. As outlined to Moody’s, we expect Realty Income to operate in the low 5x net debt to EBITDA which is within the parameters for an A-rated issuer.

The REIT’s solid operating performance is reflected by its sustained high occupancy rates (98.3% as of 3Q17) and strong fixed charge coverage of 4.3x for 3Q17, up from 4.0x at YE16. Despite the REIT’s retail focus, Moody’s expects the defensive nature of Realty Income’s net-lease portfolio which has minimal exposure to discretionary retail tenants, will continue to provide good earnings stability. However, modest industry and tenant concentration remains which continues to be a key credit challenge for Realty Income.

The stable outlook reflects Moody’s expectation that Realty Income will continue to grow in a disciplined manner without compromising its financial flexibility and leverage. It also reflects Moody’s expectation that management will maintain a strong operating profile with high occupancy rates and healthy earnings growth.

High Yield

Our threshold for making a candidate worthy of our dollars is 4% yield. Currently, Realty Income has a dividend yield of 3.87% making it slightly below our target, but within striking distance if a price correction occurs. In the past Realty Income’s yield has hovered between 3-5% so we’ll assume that if it moves closer to the high end of that range it will likely be a more valuable buy.

High Dividend Growth

Finally, we need high dividend growth to ensure that our income rises with inflation. Our threshold here is also 4%, but the higher the better as long as there is sufficient cash to pay dividends and operate safely. This is where we get some mixed signals. The past 3 years Realty Income has grown dividends at 5% compounded annually. However, over the past 5 years they have grown at only 2.39%. This makes sense though since Realty Income is a huge, mature REIT. Over the long haul though, this just isn’t enough growth to prevent us from losing money due to inflation.

Not Quite Good Enough

Despite Realty Income meeting the criteria for High Quality and High Yield, it just isn’t quite a good fit for Dividend Cultivators. With its low growth rate, it will take too long to hit a 10% yield on cost even if it is a solid grower. That doesn’t make it a bad company, but if you want to grow cash flow over time, this will be a slow one.

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