The company’s debt ratios are also healthy. Realty Income maintains a fixed charge coverage ratio of 4.1 and an interest coverage ratio of 4.6.
Each of the major credit agencies has assigned Realty Income’s senior unsecured notes and bonds an investment grade credit rating, too. Strong credit ratings help the company secure low-cost funding to finance property acquisitions.
As long as Realty Income continues to have access to external financing for growth, there should be no shortage of properties for the company to acquire.
According to National Retail’s 2014 annual report, the total size of the single tenant retail property market is estimated to be approximately $1 trillion. Realty Income’s revenue last fiscal year was just over $1 billion, leaving plenty of room for future growth.
Overall, it’s hard not to like Realty Income’s business. The company owns thousands of extremely valuable retail locations; is diversified by tenant, industry, and geography; maintains a conservative capital structure; has plenty of opportunities for future growth; and has a long track record of creating value for shareholders.
These are many of the same factors possessed by Warren Buffett’s best dividend stocks, and Realty Income will likely remain a force for many years to come.
Realty Income’s Key Risks
It’s challenging to identify many risks that could impair the long-term earnings potential of Realty Income.
The company’s diversification, financial conservatism, and focus on quality tenants and recession-resistant industries eliminate many fundamental risks faced by other REITs.
Realty Income is significantly exposed to the consumer retail sector (80% of total rent), which is constantly evolving due to changing consumer preferences and the continued rise of e-commerce.
However, Realty Income is not overly exposed to any single industry and derives the majority of its retail rent from tenants with business models that are less susceptible to online spending (e.g. dollar stores, services).
Simply put, it seems unlikely that the continued rise of e-commerce would materially impact demand across many of Realty Income’s tenants, much less jeopardize their ability to continue making rent payments.
Aside from analyzing the health of a REIT’s tenants, it’s always worth mentioning that REITs face higher capital market risk than most other types of business models.
REITs are required to pay out at least 90% of their taxable income as dividends, which means they have less capital at their disposal to grow their businesses.
As a result, they need to issue shares and raise debt to finance property acquisitions and grow their cash flow.
If capital markets freeze up and/or business fundamentals deteriorate, dividend cuts can become a real risk depending on the REIT.
Realty Income is conservatively financed and focuses on high quality tenants with less economy-sensitive businesses, helping mitigate this risk (Realty Income’s revenue declined by just 1% in fiscal year 2009, and the company recorded a 96% occupancy rate). However, it’s an important risk to remain aware of for other REITs.
Overall, Realty Income seems to have low fundamental risk.
