Real Estate Investment Trusts are some of the key vehicles for anyone looking to amass wealth through passive investment. The dividend aristocrat Realty Income (NYSE:O) has a proven track record of paying dividends for 647 consecutive months. It has also increased its payout 126 times since going public, growing it at a 4.3% compound annual rate.

Nevertheless, the stock has underperformed the overall market, going down by more than 12% in the past year and about 10% YTD. The stock's underperformance is due to the immense pressure on the US Federal Reserve, which has hiked interest rates to 23-year highs. The high interest rates of 5.25% and 5.50% have made it costly to access cheap capital for acquiring properties, shuttering investment sentiments in the sector.

Additionally, the high interest rates have affected the growth plans of some of the biggest businesses, Realty Income's most prominent tenants. The fact that these businesses cannot expand by opening new branches has made it difficult for REITs to increase the occupancy rates of some of their properties.

I have recently turned bullish on O due to the anticipated lower interest rates over the next 6-12 months, which are likely to lead to a rerating of the REIT, enhancing its attractiveness, the high dividend yield of 6%, and its diversified portfolio mitigates risk and supports stable returns. While initial signs of easing inflation are evident, the FED needs more time before cutting rates, but investors should be prepared for potential market shifts. Overall, the positive outlook and favorable conditions make this REIT a compelling investment opportunity.

Diversified Strength and Steady Growth in a Challenging Market

Amid the challenging business environment, Realty Income has proven why it is ahead of the pact and well-positioned to shrug off any challenges in the sector. The REIT boasts one of the most diversified portfolios of real estate properties that generate consistent recurring cash flow to support dependable monthly dividends. Additionally, the diversified nature of the property portfolio spread across various markets has helped the REIT maintain a low bad debt expense that has been shrinking, as evidenced below.

As of the end of the first quarter, Realty Income owned 15,485 properties. While most properties are in the US, the REIT is also increasingly expanding its footprint into Europe in pursuit of growth opportunities. With the diversified portfolio, Realty Income can achieve a 2% to 3% growth in average funds from operations without relying on the equity markets.

The firm's properties are rented out to 1,552 customers across 89 different sectors. Among its notable and reliable clients are Walgreens (WBA), Dollar General (DG), and Walmart (WMT), all of which are considered to be retailers that can withstand economic downturns. As a result, it can maintain steady income streams even during economic challenges, thanks to the quality of its clients, who are at the forefront of their industries.

The clients' diversified nature is one factor that ensures the REIT generates consistent rental income, as a slowdown in one sector is offset by growth in other sectors. The fact that none of the clients account for more than 4% of the company's annualized rent is another reason the REIT has succeeded in generating consistent rental income. Lastly, the occupancy rates stood at 98.6%, further underlining the quality and location of the properties, allowing some of the biggest and highest quality clients to be tenants.

Net Lease Model: Navigating Challenges and Driving growth with a $45 Billion Portfolio

Unlike most REITs, Realty Income has successfully navigated the challenging landscape owing to its net lease model. Under the model, the company requires tenants to cover most of their property management expenses, relieving it of maintenance costs and property taxes. The net lease approach has allowed it to pursue growth opportunities by acquiring new properties instead of participating in daily operating activities.

With a market cap of about $45 billion and a portfolio of about 15,485 properties, it is one of the largest REITs in the net lease sector, which comes with its benefits. The sheer size and financial strength allow the REIT to negotiate for better terms when seeking capital for property purchases. Therefore, it can be more aggressive with acquisitions needed to accelerate growth while still turning a profit to generate shareholder value.

6% Yield and 126 Dividend Hikes: O's Consistent Growth Amid Market Challenges

Amid the stock market's underperformance owing to investors reacting to the challenging macro environment in the REIT business, the REIT continues to pay monthly dividends and has paid out monthly dividends since 1969, which affirms its edge as one of the top stocks for anyone looking to generate passive income.

From 2010 to 2023, Realty Income increased its adjusted funds from operations (FFO) by an average annual growth rate of 6%. This achievement was made despite the company facing economic recessions and the challenges posed by the COVID-19 pandemic. Additionally, the REIT has benefited from increasing rental prices and its strategy to reinvest its retained earnings into new acquisitions and property purchases, which have grown its property holdings to more than 15,000.

Lastly, it has succeeded in raising its payout 126 times since going public in 1994, with its dividends consuming around 76% of its free cash flow. Currently, Realty Income rewards investors with a forward dividend yield of about 6%, much higher than the 4.4% yield of the ten-year treasury yield.

$9.3 Billion Acquisition Defies High Interest Rates and Fuels Global Expansion

The high interest rate environment has made accessing cheap capital for purchasing new properties harder. Nevertheless, that has not stopped the company from expanding into new markets; the REIT acquired over 2,000 properties following its purchase of Spirit Realty for $9.3 billion when the Federal Reserve was hiking rates. The acquisition spree has been the catalyst behind the REIT posting a ~34% revenue increase in the first quarter to $1.26 billion from $944 million a year ago.

While properties in Europe account for 13% of the Realty Income portfolio, there are plans to increase them as the REIT looks to diversify its portfolio further. Europe has started buying casino assets while acquiring retail space properties to tap into the region's $8.5 trillion real estate opportunity.

In the first three months of the year, it completed $598 million in investment volume at a weighted average cash yield of 7.8%. A good chunk of the investments, at 54%, took place in the UK and Europe, with a cash yield of 8.2%. The investment in Europe is part of the REIT push to diversify its revenue streams as it also looks to accelerate earnings growth.

Realty Income remains in a solid financial position, having exited the first quarter with $4 billion in Liquidity made up of cash and cash equivalent of $680.2 million and $3.2 billion under its $4.25 billion credit facility.

Bottom Line

While Realty Income has underperformed by going down by nearly a third from its 2020 highs, it has still succeeded in generating shareholder value through dividend payouts. The REIT has increased its dividends annually for three decades to the current high of 6%.

Likewise, it could bounce back from its slowdown in 2024 as the business environment improves. The Fed's cutting interest rates will significantly impact underlying fundamentals and strengthen investor sentiments. Therefore, the market pullback presents an ideal entry-level for investors seeking a solid and consistent dividend payout.