Bristol, England – May 28, 2018: Close up of Sainsbury’s shopping trolley A, shallow depth of field
Getty
Editor’s Note: The original version of this article was published in the August 2019 issue of Forbes Real Estate Investor.
I’ve owned shares in Realty Income (O) for almost a decade now. And during that time, they’ve returned an annual average of 13%. Some years, the REIT has performed even better, like in 2011 when that number jumped to 20%. On the flipside, in 2016, it dropped to 3.6%.
That’s quite the difference, but one thing has been unwavering: that this is one of the most consistent dividend payers in the world, and not just in the REIT sector. Regardless of market conditions, Realty Income has continued to reward its shareholders, paying monthly dividends for almost three decades. It’s weathered multiple recessions without a dividend disruption and increased its payout 26 years in a row.
It hasn’t coasted to get there though, offering a solid compounded average annual dividend growth rate of 4.6%.
Simplicity has always been one the secrets to Realty Income’s successful track record. By investing in net-lease properties, it has engineered a highly diversified portfolio of more than 5,800 properties. These are dispersed between 261 commercial tenants representing 48 industries located throughout 49 states, Puerto Rico, and now the United Kingdom.
That’s right: This dividend king has gone international, starting with the acquisition of 12 properties in the U.K. These are through long-term net-lease agreements with Sainsbury’s, a leading grocer founded in 1869 that operates more than 1,400 grocery and convenience stores across the U.K. and Ireland.
True to Realty Income’s acquisition strategies, Sainsbury’s checks off a lot of boxes, since it:
- Is a blue-chip grocery operator with a seasoned and highly-regarded management team
- Works within a defensive, non-discretionary industry
- Has shown proven strength through multiple economic cycles.
Sainsbury’s same-store sales grew at an average annual rate of 4.7% during 2007 to 2010, significantly outperforming other U.K. retailers and overall GDP during the Great Recession. In short, it fits well within Realty Income’s approach of making relationship-based transactions with well-placed, well-established, well-coordinated industry leaders.
Geography is the only difference in this transaction.
Realty Income’s portable business model, cost of capital, and scalability represent core reasons for making the move across the pond. According to the company, the U.K net-lease market is “ripe for sale leaseback consolidation.” It estimates there is $11 trillion worth of commercial real estate stock in the European market, with only $3 trillion of it owned by professional real estate firms.
The company estimates that corporate-owned commercial real estate stock is 2x greater in Europe than in the U.S., representing a very tempting void for, say, a well-capitalized, sizable, and scalable institutional investor to fill.
Recognizing that, the company plans to establish an office in London to further grow its European portfolio. Incumbent competition is modest in Europe, and the enterprise value of the public REIT market in the U.K. specifically is estimated to be approximately $115 billion – roughly the size of the publicly traded net lease REIT universe in the U.S.
DEBUNKING THE NARRATIVE
Now that Realty Income has a new pool to fish in, so to speak, the narrative that it’s too big in the U.S. to expand any more should jump ship. It is now in an excellent position to increase its growth without increasing risk. This international move enhances its domestic business. And it can now expand its market from a position of strength.
Below is a look at the historical U.S. volume. I think you’ll find all the charts included worth paying attention to.
The Sainsbury sales-leaseback deal size is currently worth $550 million, with an initial cap rate of 5.8% (U.S. equivalent). This translates into a 200-basis point spread to leverage-neutral weighted average cost of capital (WACC). The deal is $0.04 per share, accretive to Realty Income’s adjusted funds from operations (AFFO).
Realty Income shares are now trading near all-time highs. Shares recently traded at $68.97, with a P/AFFO multiple of 21.3x (compared to a norm of 17.4x) and a dividend yield of 3.9%. Our Trim Target is $70 per share.
Perhaps the company should be compared with Prologis (PLD), another S&P A-rated REIT with international operations. Prologis now trades at 29.8x P/AFFO, with a 2.6% dividend yield.
We currently have a Hold rating on both REITs due to valuation. We like them, but they’re too expensive right now for new investors to consider getting in. However, feel free to put them on your watchlist and wait for pullbacks to pounce.
In conclusion, Realty Income has been one of the best holdings in the Durable Income Portfolio. It represents 6% of the overall exposure (in the Durable Income Portfolio).
Bottom line: We believe its international expansion represents a tremendous opportunity for the company to scale its business model and utilize its low cost of capital advantage.
One final note on the subject to keep in mind is this: It does signals that there’s less interest for the company to seek merger and acquisition (M&A) opportunities with, say, Spirit Realty (SRC). There is greater opportunity to find higher-quality properties elsewhere, allowing Realty Income to be more selective in growth with a much lower-risk profile.
Kudos to the management team for making this bold move.
I own shares in O.