Realty Income (O) Analysis Highlights:

• Recent Price: Price stock recently traded at time of publishing
• Recent Price Range: Price range in past 52 weeks
• Price Target: Estimated Fair Value for shares
• Estimated Gain / Loss: Difference between Recent Price & Price Target
• Shareholder Ownership: Repurchasing or dilution of outstanding shares
• Dividend Safety Score: Risk of reducing or eliminating dividend
• Buy / Sell Score: Indicates if we are buying or selling shares

Understanding the Business

Realty Income (O), The Monthly Dividend Company®, is an S&P 500 company which has consistently increased its dividend for over 25 years. As a real estate investment trust (REIT), it distributes at least 90% of its taxable income annually in the form of dividends to shareholders. These dividends are supported by cash flow from real estate owned or held interests in under long-term net lease agreements with commercial clients.

Founded in 1969 and listed on the NYSE in 1994, Realty Income has been acquiring and managing commercial properties for 55 years. As of December 31, 2023, they owned or held interests in 13,458 properties in the US and Europe. On January 23, 2024, they announced a merger with Spirit Realty Capital, Inc., which included 2,018 US retail, industrial, and other properties across 49 states. This transaction enhances diversification and depth in their real estate portfolio, strengthening relationships with existing clients and attracting new ones.

Business Operations

As of December 31, 2023, Realty Income had 13,265 properties leased under net lease agreements, with clients responsible for monthly rent and property operating expenses. Rent increases are based on fixed increases, inflation-related increases, or additional rent calculated as a percentage of gross sales above a specified level.

• Dollar amounts represented in Thousands for the table above

Total portfolio Annualized Contractual Rent is the monthly cash amount charged to clients, including base rent receivables, multiplied by 12 and excluding percentage rent. It is a useful supplemental operating measure as it excludes properties no longer owned at the balance sheet date and includes annualized rent from properties acquired during the quarter. It has not been reduced to reflect reserves recorded as reductions to Generally Accepted Accounting Principles (GAAP) rental revenue.

Top 10 Industry Concentrations

Realty Income’s business focuses on leasing property to clients, primarily on a net basis across various geographic boundaries and industries. The REIT is prioritizing diversification as a key component of their investment philosophy. Therefore, below is a table representing their property portfolio, classified according to the business of each client, to maintain a comprehensive understanding of their portfolio.

Client Diversification

The table below displays the top 20 clients in Realty Income’s property portfolio, as a percentage of total annualized contractual rent, as of December 31, 2023.

Lease Expiration

The table below provides details on lease term expiration in Realty Income’s portfolio, excluding client-optional lease extension rights, and their contribution to total portfolio annualized contractual rent as of December 31, 2023, in thousands.

Business Strategies

Realty Income manages a diversified portfolio of commercial properties under long-term, net lease agreements, resulting in consistent and predictable income. Clients are responsible for monthly rent, property operating expenses, taxes, insurance, and maintenance. Rent increases are based on fixed increases, inflation-tied increases, or additional rent calculated as a percentage of gross sales above a specified level. This approach provides a more predictable income stream compared to other real estate portfolios and offers potential for growth in rental income.

Diversification is a key component of the company’s investment philosophy, reducing vulnerability associated with single concentration. As of December 31, 2023, the company owns or holds interests in 13,458 properties across all 50 US states, Puerto Rico, the UK, France, Germany, Ireland, Italy, Portugal, and Spain. The company aims to expand geographically across Europe and build relationships with new multinational clients seeking a real estate partner with an expanding geographic footprint.

Investment Strategy

Realty Income aims to acquire, invest in, and develop high-quality real estate considered crucial for client success. The company seeks clients with reliable, sustainable cash flow, multiple revenue sources, willingness to sign a long-term lease, and large real estate owners.

The REIT invests in properties or portfolios owned or leased by clients who could become leaders in their respective businesses, supported by factors such as prime real estate locations, pricing, merchandise assortment, service, quality, economies of scale, consumer branding, e-commerce, and advertising.

Furthermore, Realty Income has an internal team dedicated to sourcing such opportunities, often using relationships with clients, owners/developers, brokers, and advisers to secure transactions. This team also conducts thorough research and analysis to identify appropriate property locations, clients, and industries for investment, utilizing their research expertise to uncover investment opportunities in markets where they believe they can add value.

Realty Income’s retail investment strategy focuses on clients with a service, non-discretionary, or low-price-point component to their business. They target clients with e-commerce resilience or strong multichannel retail strategies, integrating brick-and-mortar and mobile browsing. Moreover, Realty Income’s portfolio is optimized by asset class and industry, with periodic reviews and stress testing to ensure consistent earnings growth and value creation. As of December 31, 2023, 91% of Realty Income’s annualized retail contractual rent came from clients with a service, non-discretionary, or low price point component to their business.

Underwriting Strategy

To be considered for acquisition by Realty Income, investments must meet strict underwriting requirements. These criteria include industry, client, market conditions, expected financial returns, real estate value, and store profitability for retail locations.

Real estate investments typically involve owning the land and buildings a client uses for business or revenue generation. Clients must retain profitable and critical locations for survival. In case of reorganization, clients are less likely to reject a lease of a profitable or critical location, as this would terminate their right to use the property. As property owners, Realty Income aims to outperform unsecured creditors in reorganization scenarios. If a property is rejected, the company can either lease it to a new client or sell it. To mitigate the risk of default on real estate leases, Realty Income will monitor client’s performance and consider selling locations that meet their disposition criteria.

Realty Income’s team conducts thorough reviews of clients’ business segments and industries, including a thorough credit research before any transaction. This includes reviewing reports, financial statements, debt and equity analyst reports, corporate credit spreads, stock prices, and other financial metrics. The REIT also conducts due diligence, monitor clients’ credit quality, and provide summaries to management on an ongoing basis.

As of December 31, 2023, 39.6% of Realty Income’s total portfolio annualized contractual rent came from properties leased to investment grade clients, their subsidiaries, or affiliated companies. The top 20 clients represented 40.2% of the annualized rent, with 10 having investment grade credit ratings or being subsidiaries or affiliates of investment grade companies.

Asset Management Strategy

Realty Income aims to increase earnings and dividends by actively managing its assets. This includes increasing rent during lease expiration, maximizing exposure to specific clients and markets through re-leasing and selectively selling properties, maximizing asset-level returns on renewed, re-leased, or sold properties, and leveraging internal capabilities to enhance individual properties, pursue alternative uses, and generate additional revenue.

The company’s credit and predictive analytics research involves monitoring their portfolio for potential changes which could impact client performance, industries, and real estate locations. Realty Income analyzes their portfolio to optimize returns and improve credit quality. Additionally, their active asset management strategy involves asset sales when reinvestment is expected to generate higher returns, enhance credit quality, extend lease terms, and decrease client, industry, or geographic concentration. This active portfolio management is crucial for maintaining high occupancy and achieving their long-term growth objectives.

Management’s Perspective

Realty Income, The Monthly Dividend Company®, is an S&P 500 company that has consistently increased its dividend for over 25 years. As a REIT, it distributes at least 90% of its taxable income annually in the form of dividends to stockholders. The company owns or holds interests in a diversified portfolio of 13,458 properties across all 50 US states, Puerto Rico, the UK, France, Germany, Ireland, Italy, Portugal, and Spain. The portfolio has approximately 272.1 million square feet of available space for clients in 86 different industries. 98.1% of the properties are single-client, with 13,007 leased, and the remaining are multi-client properties. The total portfolio has a weighted average remaining lease term of approximately 9.8 years.

Realty Income’s goal is to provide dependable monthly dividends to shareholders which increase over time. They have historically met their capital needs, including funding real estate acquisitions, property development, and capital expenditures, through issuing common stock, preferred stock, long-term unsecured notes, and term loan borrowings. Furthermore, Realty Income believes common stock should be the majority of their capital structure over the long term. The REIT may issue common stock when the share price allows for incremental investment into additional properties or permanent financing of properties initially financed through their revolving credit facility, commercial paper programs, or shorter-term debt securities.

Spirit Realty Capital Merger

On January 23, 2024, Realty Income completed the merger with Spirit, which included 2,018 US retail, industrial, and other properties across 49 states. This transaction enhanced the real estate portfolio’s diversification and depth, strengthening existing client relationships and attracting new ones, as the assets complemented Realty Income’s existing portfolio.

Increases in Monthly Dividends

Since Realty Income’s NYSE listing in 1994, they have consistently increased their dividends, paying 105 consecutive quarterly increases, showcasing their 55-year history of monthly dividends and dividend increases. Furthermore, Realty Income plans to continue their monthly dividend policy, but cannot guarantee the continuation of the current level, the pattern of increasing dividends per share, or the actual dividend yield in any future period.

Inflation

Leases typically allow for limited rent increases due to fixed increases, consumer price index, or client sales volumes. Inflation is expected to cause these provisions to result in rent increases over time. However, when inflation exceeds rent increases, rent increases may not keep up with inflation and other costs. Realty Income’s strategic focus on net lease agreements reduces their exposure to rising property expenses due to inflation, as clients are responsible for property expenses.

However, substantial inflationary pressures and increased costs may adversely impact their clients’ ability to pay rent if operating expenses exceed revenue increases. Inflationary periods may also lead to increased financing costs, making it difficult to refinance debt at attractive rates or at all. Additionally, inflation may adversely affect the properties they can acquire if the cost of financing exceeds their anticipated earnings, limiting the properties they can acquire.

Talent Management

Realty Income’s management team is dedicated to fostering an inclusive culture by hiring talented employees with diverse backgrounds and perspectives. Key objectives include striving for open communication and a fulfilling career for all team members. Management encourages employees to work as a “One Team” and are committed to providing an engaging work environment centered on the values: Do the Right Thing, Take Ownership, Empower Each Other, Celebrate Differences, and Give More than We Take.

Realty Income’s corporate culture is built on dedicated employees, who are described as the company’s most valuable assets. As of December 31, 2023, the workforce consisted of 418 professionals, with most recruited and hired from local communities. Various leadership development programs and training on critical topics are offered to employees such as ethics, insider trading, anti-discrimination, cybersecurity, diversity, equality and inclusion, safety, and other company policies.

Employee retention is essential for supporting a positive culture and productive workforce. Realty Income believes in competitive compensation and benefits packages, including medical, dental, and vision coverage, 401(k) plans with matching opportunities, paid time-off or equivalent vacation, disability and life insurance, and the ability to earn equity in the company subject to applicable vesting periods.

Dividend Policy

Distributions are paid monthly to holders of shares of Realty Income’s common stock.

In 2023, the REIT distributed $2.11 billion to common stockholders, accounting for 115.9% of estimated taxable income of $1.82 billion. To maintain their status as a REIT, Realty Income must distribute at least 90% of their taxable income annually. Furthermore, they are subject to income tax if they distribute less than 100%. As a result, the company has implemented measures to reduce or eliminate their tax exposure as a REIT, with no provision for federal income taxes except for their taxable REIT subsidiaries. Lastly, their estimated taxable income reflects non-cash deductions for depreciation and amortization. Realty Income plans to continue making sufficient distributions to meet these requirements and reduce or eliminate their income tax exposure.

Cash on hand and funds from operations are sufficient to support their current level of cash distributions as they distributed $3.051 per share, representing 76.3% of their diluted Adjusted Funds from Operations Available (AFFO) per share of $4.00.

The Board of Directors has the discretion to determine future distributions based on various factors such as results of operations, Funds from Operations (FFO), Adjusted Funds from Operations (AFFO), cash flow, financial conditions, capital requirements, annual distribution requirements under the REIT provisions, debt service requirements, and other relevant factors. The credit facility utilized by Realty Income contains financial covenants which could limit distributions payable in case of default and prohibit payment of distributions on common stock if the company fails to pay principal or interest on borrowings under the credit facility, subject to a grace period.

Distributions of earnings and profits for federal income tax purposes are generally taxable to stockholders as ordinary income, except when the REIT recognizes capital gains and declares a capital gains dividend, or if these amounts constitute “qualified dividend income” subject to a reduced tax rate.

Government Regulations

Compliance with governmental regulations significantly impacts Realty Income’s business, including capital expenditures, earnings, and competitive position. Costs to monitor and take actions to comply with these regulations include federal securities laws, stock exchange requirements, REIT tax laws, environmental and health and safety laws, local zoning, usage regulations, and the Americans with Disabilities Act of 1990. Overall, Realty Income believes their properties generally have the necessary permits and approvals, ensuring compliance with applicable laws and regulations.

Environmental Regulations

Real estate property investments can lead to potential environmental liability due to federal, state, and local environmental laws and regulations. Property owners can face liability for environmental contamination caused by the presence or discharge of hazardous substances on their properties, regardless of their knowledge of the contamination, timing, cause, or party responsible. Some properties may contain or have contained petroleum product storage tanks or involve the use of hazardous or toxic substances.

Certain laws and regulations mandate property owners, operators, or tenants to investigate and clean up hazardous or toxic substances, and may be held liable for property damage, investigation, and monitoring costs. Liability may be for the full amount, or a party held jointly and severally liable may seek contributions from other responsible parties. Strict environmental laws regulate activities on property, imposing fines or penalties for violations.

Environmental laws regulate asbestos-containing materials (ACM), requiring building owners and management to identify hazards and warn employees. Violations can lead to fines and lawsuits. Federal, state, and local laws also govern ACM removal, handling, and disposal during construction, remodeling, renovation, or demolition. Improper handling can result in liability and fines. Properties may also contain harmful mold or airborne contaminants, requiring remediation or increased indoor ventilation.

Americans with Disabilities Act of 1990

Realty Income’s properties are required to comply with the Americans with Disabilities Act (ADA), which mandates buildings be accessible to people with disabilities. Noncompliance with these laws could result in fines, damages to private litigants, and costs to make modifications. Tenants are generally responsible for compliance, but Realty Income could be held liable as the property owner for a tenant’s failure to comply. As of December 31, 2023, the company has not received notice from any governmental authority or are aware of any non-compliance with the ADA which would have a material adverse effect on the business, financial position, or results of operations.

Cybersecurity

Realty Income has a cyber risk management program responsible for assessing, managing, mitigating, and responding to cybersecurity threats. The program is designed and assessed based on the National Institute of Standards and Technology Cybersecurity Framework (NIST CSF) and is integrated into the enterprise risk management system. It addresses IT networks and related systems essential to business operations. The company maintains controls and procedures, including third-party oversight procedures and cybersecurity training for all employees, to ensure prompt escalation of cybersecurity incidents. Additionally, Realty Income partners with third parties to identify, assess, and manage cybersecurity risks, including professional services firms, consulting firms, threat intelligence service providers, and penetration testing firms.

The cybersecurity program and designated incident response team are comprised of key employees and third-party information security experts from leading firms. The company has established comprehensive incident response and recovery plans and continues to evaluate their effectiveness. The Cybersecurity Risk Committee, chaired by the Head of IT, provides oversight and guidance related to cybersecurity risk management decisions. The company faces risks from cybersecurity threats which could materially affect its operations, business strategy, results of operations, or financial condition.

Risk Factors

Investment in Realty Income stock or debt securities involves risks and uncertainties. Realty Income aims to manage and mitigate these risks, but many are outside its control and cannot be eliminated.

Key Risk Factors

1. Realty Income operates in highly competitive real estate markets, which could potentially negatively impact its earnings due to competitive pressures.
2. Real property investments can lead to environmental liability, as owners may face liability for contamination caused by hazardous substances. This liability can affect the property’s ability to operate, lease, or sell, and may result in remediation costs or third-party liability claims. Additionally, properties leased for industrial purposes may have hazardous substance storage, which could affect the company’s financial condition and ability to distribute dividends. Environmental laws also govern asbestos-containing materials, imposing fines and penalties for non-compliance.
3. Since December 31, 1994, the company has been organized and operating to qualify as a REIT. However, the company cannot guarantee that it will continue to qualify as a REIT. Qualification requires at least 95% of gross income from qualifying sources and at least 90% of annual taxable income must be distributed to stockholders . Failure to meet these requirements could result in penalties, reduced investment opportunities, and adverse effects on capital stock and debt securities market prices.
4. Taxation rules are constantly reviewed by legislative bodies and the IRS and Treasury. Changes could adversely affect the company’s ability to qualify as a REIT, its federal income tax consequences, and the tax treatment of sale-leaseback transactions.
5. Future growth depends on capital raising, which can dilute common stockholders’ interests through equity securities, stock incentive plans, and preferred stock issuance.
6. The company has acquired properties through tax deferred contribution transactions in exchange for partnership units in an operating partnership. This structure may result in stockholder dilution, as the units may be exchanged for common stock shares. This could reduce tax depreciation over the properties’ tax life and require restrictions on disposing or refinancing debt. The company may also be required to incur or maintain debt to allocate debt to contributors, maintaining their tax bases. If actions incur taxable gain, the company may be required to make them whole under tax protection agreements. These restrictions could limit the company’s ability to manage, control, sell, or refinance assets on favorable terms or at a time without these restrictions.
7. Real estate investments are illiquid, making it difficult to quickly respond to economic changes and imposing tax and regulatory regimes on properties. No assurances can be given that full value will be recognized for properties required to sell for liquidity reasons. The inability to respond rapidly to changes in investment performance could negatively impact the company’s financial condition and operational results. Therefore, no assurances can be given about the full value of properties required to be sold.
8. Realty Income properties must comply with the Americans with Disabilities Act of 1990 (ADA), which requires accessible buildings for people with disabilities. Non-compliance could result in fines or damages. Leased clients may cover costs, but increased expenses could affect their ability to cover costs. Compliance with fire, safety, and land use regulations could also affect our operations.
9. Climate change poses risks to Realty Income’s business, including extreme weather, rising sea levels, and reduced demand for properties. These risks could affect their reputation, financial condition, and operations. The REIT aims to promote sustainability and comply with laws, but may face significant capital expenditures and reputational damage. Their sustainability strategies may not result in reduced operating costs or higher occupancy rates.
10. Realty Income’s charter outlines restrictions on ownership and transfer of common stock to maintain status as a REIT for U.S. income tax purposes. For instance, it prohibits any person from acquiring more than 9.8% of outstanding shares. These restrictions may have anti-takeover effects, reducing the risk of third parties acquiring control, which could negatively impact the market price of common stock.
11. Cyber-attacks and security incidents pose a significant threat to businesses, posing a threat to their confidentiality, integrity, and availability of systems and information resources. These attacks can be intentional or unintentional, and can be triggered by employees, contractors, or third-parties seeking unauthorized access to systems to disrupt operations, corrupt data, or steal confidential information. The risk of a cybersecurity breach or operational disruption has increased due to the increasing number, intensity, and sophistication of attempted attacks and intrusions worldwide, particularly as remote working becomes more common.
12. Realty Income’s information technology networks and related systems are essential to business operations and may be critical to some clients’ operations. While the REIT makes efforts to maintain the security and integrity of these systems, there is no assurance security efforts will be effective or attempted security breaches or disruptions will not be successful or damaging.
13. Third-parties provide essential software, technologies, tools, and services such as payroll, human resources, electronic communications, data storage, and finance and treasury functions. In the course of business, Realty Income will collect, process, transmit, and store sensitive data within systems and utilize those of third-party providers, including intellectual property, proprietary business information, client information, suppliers, and partners, as well as personally identifiable information.
14. The company’s ability to distribute common stock and outstanding preferred stock, make payments on debt, fund acquisitions, and fund capital expenditures depends on its ability to generate cash in the future. The company cannot guarantee sufficient cash flow from operations or future borrowings to fund these needs, and cannot make assurances about the availability of sufficient borrowings.
15. Global equity and credit markets have experienced significant price volatility, dislocations, and liquidity disruptions, affecting market prices and spreads on debt financing. These uncertainties may negatively impact access to financing, acquisitions, and property transactions. They may also affect market value, income, and lease rates, potentially affecting the economy.
16. Inflationary periods could negatively impact variable rate debt and operations. Rent increases may not keep up with inflation and costs. Government regulations may limit lease adjustments, and the shift from the Retail Price Index to alternative measures may negatively impact lease revenue. Long-term inflation may exacerbate these issues.
    

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