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In our last article on Realty Income (NYSE:O), we highlighted that investors are in a better place after eight years of lackluster returns. We looked at two different extreme long-term scenarios and found it hard to view this as a bad investment no matter what happens.
This allows the dividends to be reinvested, creating a nice income profile. For long term holders, we believe this is a good investment as long as you keep your investment horizon long and your expectations modest. We are now upgrading this to a Buy recommendation.
Source: Worst drought in 8 years
This has worked and the company's stock price has practically skyrocketed as if they had changed their name to “Realty A Income.” We look at the recent performance and market price of interest rate cuts and want to let you know where we stand.
Q2 2024
Realty Income slightly beat its second-quarter 2024 forecast, but the amount appears to be tied to the timing of its operating cash flow (FFO). The company did not change its guidance for the current fiscal year.
Realty Income 2024 Q2 Presentation
The analysts yawned, and so did we, in no rush to change their forecasts.
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This was despite significantly lower interest rates and credit spreads being used compared to initial guidance. Some of the headwinds the bears spoke of may be occurring in the background as Real Estate Income sells properties that are underperforming and/or have a high risk of future vacancies. While you typically don't see the damage from this directly, the higher cap rates (lower prices) on these properties tend to offset the growth numbers to some extent.
Europe
One of the big themes for Realty Income over the last few years has been its expansion into Europe. Long ago, Realty Income's sole focus on the U.S. was often cited as a positive. But bulls are starting to embrace transatlantic capital flows, and frankly, they have no choice. Realty Income is deploying two-thirds of its capital in Europe for Q2 2024, really pushing its dominance there.
Realty Income 2024 Q2 Presentation
It is very interesting to see Realty Income highlighting the multi-trillion dollar opportunity in Europe.
Realty Income 2024 Q2 Presentation
The company takes the trouble to show how this specifically benefits both the buyer and the purchaser (in this case, real estate income).
Realty Income 2024 Q2 Presentation
An interesting thing to note here is that REITs incorporate share buybacks into their model. Obviously, this means they are dealing with publicly traded companies. Once you understand this part, you can understand why. European companies are able to sell properties at relatively high cap rates in sale-leaseback transactions because their shares are cheap. That part is shown in the next graph.
Financial Times
So this is a pretty interesting trend that Realty Income is taking advantage of, and we don't see it changing unless U.S. stocks crash by more than 50%. Conversely, if European stocks have a major bull market, we might see that. But either way, Europe is the place to be for now.
Realty Income 2024 Q2 Presentation
the final countdown
With markets at all-time highs and inflation well above its own targets, the Fed has embraced the idea of cutting rates — all that's left is to deliver on the priced 200 basis points of cuts.
X
To the extent that this coincides with a perfect soft landing, Realty Income's valuation will be high. If this were to happen, I wouldn't have any problem with the stock revaluing to 17x. After all, much lower quality REITs like Iron Mountain Incorporated (IRM) trade at exactly twice that multiple. Of course, the only time a true soft landing occurred after a series of rate hikes was in 1994, and that was without an inverted yield curve.
Bank of America
So it remains to be seen whether this can be achieved.
verdict
There is another downside risk for the company if the rate-cutting cycle proves too late to stave off a recession. Alternatively, the full extent of the rate cuts may not be priced in if inflation resets at a higher base and starts to rise again. The stock looks fairly priced for what it offers, but it's not obviously cheap like it was just three months ago. We change this to Hold and believe there are better real estate stocks to speculate on in the medium term.
Realty Income Corporation 6% PFD SER A (NYSE:O.PR)
If the rate cut predictions are accurate, O.PR is slightly undervalued. If the Fed Funds rate is cut by 200 basis points and a soft landing occurs, this stock will likely be redeemed. Realty Income dislikes preferred stocks, which is due to their acquisition of Spirit Realty Capital. We do not own this stock because we were long Rexford Industrial Realty, Inc. 5.875% PFD SER B (REXR.PR.B), which had a high yield at the time (and still has) and room to grow above par (and still has). We rate O.PR a Hold, but it is a low-risk stock for those who believe all the rate cuts will come to fruition.
Please note that this is not financial advice. It may seem that way, but surprisingly it is not. Investors are urged to do their own due diligence and consult with professionals who understand their objectives and constraints.
