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Investors are selling real estate investment trusts, or REITs, with both hands right now. The prospect of higher interest rates over the next year has caused investors to rush for the exits, fearing higher costs of capital for these interest rate-sensitive stocks.
There is truth to the fact that REITs are vulnerable to rising interest rates. The business model involves taking out a lot of debt to finance purchases of real estate. But the well-run, financially sound REITs have survived periods of much higher interest rates in the past.
Any increase in interest rates in the United States is likely to be a gradual, slow process. The last thing the Federal Reserve wants to do is risk shocking the financial system by raising interest rates too fast. For this reason, it’s likely the best-managed REITs like Realty Income (NYSE: O) will be just fine, even if rates go up from here.
Realty Income is an extremely stable company. It owns more than 4,300 properties rented under long-term leases. These properties are primarily rented to retail tenants that come from various industries such as distribution centers, health and fitness facilities, and drugstores.
Growing Profit Stream
A unique aspect of Realty Income’s business model is that it engages in “net” leases, meaning the tenant is responsible not just for paying rent every month, but also for covering the major operating expenses such as taxes, maintenance and insurance.
In addition, Realty Income has a diversified tenant portfolio. Its sources of lease revenue are spread amongst 47 industries, 236 commercial tenants, across 49 states and Puerto Rico.
This results in a steadily growing stream of profit. Last year, Realty Income’s revenue jumped 19% year over year, and its funds from operation, or FFO, grew 7%. FFO is a non-GAAP financial metric that is an alternative to traditional GAAP earnings per share.
The possibility of higher interest rates shouldn’t overly concern investors. Realty Income has a strong balance sheet and is conservatively capitalized. The company holds $5.4 billion in debt compared to $11 billion in assets.
Dividend Track Record
Realty Income is a great blue chip REIT, for several reasons. First, it pays its dividends monthly, and in fact calls itself The Monthly Dividend Company. This is more attractive than a quarterly or semi-annual payment, because monthly dividends allow investors to compound their wealth even quicker.
Furthermore, Realty Income has a long track record of paying and raising its dividend over time. With the payment of the July dividend, it has made 540 consecutive monthly dividend payments and paid over $3.5 billion in dividends throughout its 46-year operating history. What’s more, it has raised its dividend 81 times since its listing on the New York Stock Exchange in 1994.
Plus, from a valuation perspective, Realty Income is now relatively cheap. Based on its 2014 FFO of $2.58 per share, the stock trades for a very reasonable 17 times FFO. This is a cheaper earnings multiple than the S&P 500, which trades for 19 times earnings.
Shares of Realty Income are down 8% in the past six months, but this has simply created an excellent buying opportunity. The stock now offers an attractive 5% dividend yield and a comfortable valuation, and should be a top consideration for income investors.
Dividends for Every Month of the Year
If you’re looking for just one dividend stock to round out your income stream, consider a little-known company that pays out dividends 12 months of the year.
Click here to see the full details of this company in my Dividend Calendar…