The words ‘Dividends 101’ on a yellow legal padGetty
Excerpts of this article appeared previously in the January 2019 edition of the Forbes Real Estate Investor.
Most people don’t consider REITs to be real movers and shakers. They’re real estate plays, and boring (or at best, confusing) real estate plays at that.
There are properties. There are property managers. And there are leases.
That’s pretty much it.
But let’s face it: Sometimes, boring is best. Sometimes “boring” isn’t so boring. Especially when “boring” just raised its monthly cash dividend from $0.2210 a share to $0.2255.
That’s the news Realty Income Corporation (NYSE: O) just announced on Tuesday, and it’s good for shareholders of record as of February 1. This means you still have time to get into a stellar stock with an ever-rising dividend.
The fact that Realty Income hiked up its offering right now isn’t a surprise for anyone who knows the REIT. This business has long been a bellwether in the net lease sector. For more than two decades now, it’s been increasing its payouts every year – for 24 years and counting.
In fact, this January announcement marks an auspicious event: the company’s 100th dividend increase since it first went public in 1994.
Is anyone else thinking of the adage, “Slow but steady wins the race”?
Regardless, it’s clear that Realty Income Corporation is in good standing. It’s also in good hands with new CEO Sumit Roy in charge.
By all appearances and indications, he’s more than respecting this REIT’s long and impressive traditions. If fact, let’s talk to him about it now…
A Dividend-Centered Interview With Realty Income Corporation
Brad Thomas: What is your background in net lease investing?
Sumit Roy: I have spent 14 years directly and indirectly investing in net lease assets. 7 of those years were as an Investment Banker covering net lease REITs (including Realty Income) where I gained familiarity with the asset class. The other 7 years have been at Realty Income after joining the company in 2011 as a Senior Vice President in Real Estate Acquisitions. It was during this time that I learned the many nuances of direct investment of net lease properties.
Since 2013, I’ve held the Chief Investment Officer and Chief Operating Officer titles at various times while chairing the company’s Investment Committee.
Brad Thomas: In a few sentences, what is the value proposition of Realty Income?
Sumit Roy: Our mission is to deliver monthly dividends that grow over time to our shareholders. We are The Monthly Dividend Company®. Our founders, William and Joan Clark, started with a simple idea – to use the rent collected from commercial properties held under long-term leases to support monthly dividends to shareholders. Today, we continue to maintain that same commitment to the dividend.
Brad Thomas: Realty Income has successfully avoided many retail bankruptcies, but I’m curious as to risks related to Walgreens and the threat of Amazon?
Sumit Roy: We are very selective with the properties and tenants we invest in. This year we have sourced approximately $26 billion of investment opportunities while closing on only 6% of that volume.
Our focus on real estate with strong fundamentals and high-quality tenants has helped us to avoid significant credit issues in the portfolio. The trends that we see in retail right now is that traditional retailers are embracing the “omni-channel” strategy – while online retailers are opening physical locations. So, brick and mortar has and will have a place in the retail industry.
As it relates to drug stores, Walgreens and CVS in particular, our drug stores are located in outstanding real estate locations, which is very important as convenience is the number one factor for consumers in choosing a pharmacy. Both retailers are rolling out same-day/next day delivery services and can use their real estate locations as distribution centers to reach the majority of the US population.
Walgreens and CVS combined have almost 50% market share of the prescription industry with networks that will be very hard for Amazon to replicate. With ~20,000 stores combined, these two major drug store chains are located within 5 miles of 80% of the US population.
Additionally, drug stores are driving more traffic into the store by incorporating a more service-oriented strategy (which is impossible to replicate for an online pharmacy) by opening health clinics inside the stores. The merger of CVS and Aetna is largely predicated on the cost synergies a large insurer can realize by steering patients to a clinical setting rather than paying for pricier outpatient services.
Brad Thomas: It appears that Realty Income has continued to evolve into other categories, outside of retail. Can you explain your rationale for that strategy?
Sumit Roy: Our investment strategy targets retailers that perform well through a variety of economic environments. Within our retail portfolio, over 90% of rent comes from tenants with a service, non-discretionary, and/or low price point component to their business.
We believe these characteristics allow our tenants to operate in a variety of economic environments and compete more effectively with e-commerce. Our size and scale also allow us to continue to review new opportunities and we are always assessing new areas of growth.
Our expansion into select verticals that we have underwritten carefully and pursued is part of our history. In 2010, for example, we expanded into the industrial property type and also entered into a sale-leaseback transaction with Diageo to acquire vineyard land in Napa Valley. Both of these decisions have been very successful for Realty Income.
Brad Thomas: Let’s talk growth, starting with organic growth. What can investors expect in terms of normalized rent growth?
Sumit Roy: Approximately 90% of our leases have some kind of an increase built into them (every year, every 5 years, percentage rent, CPI). Our same-store rent growth has been around 1% historically and we expect this trend to continue into the future. Using our leverage profile, we expect this to result in approximately 1.5% annual levered returns.
Brad Thomas: What about external growth? I’m particularly interested to understand how you can generate sound margins in a competitive environment?
Sumit Roy: There are plenty of opportunities in the net lease space. Our size allows us to execute large sale-leaseback transactions on a negotiated basis, as we are the only company who can complete these transactions without creating tenant or industry concentration issues.
Over 80% of our investment volume this year has been sale-leaseback transactions, which speaks to the benefit of the long-term relationships that we have developed with our tenants and partners over our nearly 50-year history.
Our cost of capital is our main competitive advantage. We have the lowest cost of capital among our competitors, which allows us to invest in high quality real estate leased to leading tenants and still earn attractive investment spreads. As we further evolve and execute our strategy, we will continue to consider all executable avenues for external growth
Brad Thomas: Congratulations on the two A ratings. How does this provide Realty Income with a competitive advantage, in terms of cost of capital?
Sumit Roy: Thank you, Brad. The rating upgrade from S&P has placed as in an elite group of only a few US REITs with two ‘A’ ratings. Our cost of debt has decreased by ~20-25 basis points since we received our first ‘A’ rating from Moody’s about a year ago. This has served to further widen our cost of capital advantage vis a vis our competitors.
As I mentioned before, our cost of capital is our main advantage that differentiates us from the rest of our peers and allows us to invest in high quality properties while generating attractive investment spreads. Acquiring the highest quality assets allows us to grow our dividend with consistent and predictable cash flow. In other words, it supports our shareholders’ abilities to sleep well at night.
Brad Thomas: A few years ago, I asked Realty Income’s previous CEO, Tom Lewis, about the “secret sauce” for Realty Income’s dividend growth record. I’ll ask you the same question, “what’s the recipe for success”?
Sumit Roy: Discipline. By staying true to our conservative underwriting and managing our balance sheet responsibly, we have been able to generate a consistent cash flow stream supported by rent that is paid by quality tenants leasing space in desirable markets. Despite having a cost of capital that allows us to be extremely competitive in the bidding process, we avoid stretching our investment parameters if we don’t feel comfortable with the risk/return profile.
We also remain steadfast in our belief that a well-capitalized balance sheet with modest leverage and laddered debt maturities will help protect our company in tough times. We were one of only a handful of companies during the Great Recession that actually raised its dividend and we remain proud of that accomplishment. Our conservative capital structure also allowed us to avoid having to issue dilutive equity during the downturn.
Brad Thomas: Finally, as the new CEO, you obviously intend to lead the company into many more years of dividend growth. How do you think about scale? Could your become ever become larger than Simon Property Group (SPG)?
Sumit Roy: Great question, Brad. I think that one of the greatest opportunities facing our company today is our size and scale, and strong relationships with our tenants that we have built over our nearly 50-year history.
As I mentioned, our size and scale afford us the ability to complete large sale-leaseback transactions on a negotiated basis, as we are the only company who can executive these types of transactions. I don’t see a limit to our growth. The net lease market is vast and very fragmented and unlike some other REITs, we are not constrained to investing in only certain geographies or in a narrow range of property types.
Rest assured, we will remain true to the core tenets of what has generated a loyal shareholder following and continue to pursue net-leased assets that deliver long-term, stable cash flows for our shareholders.
The future is bright. I am supported by a talented team, a proven business model, and a sector-leading cost of capital. We are grateful for the support of our many loyal shareholders and hope to continue generating dependable returns as The Monthly Dividend Company®.
The author owns shares in Realty Income.