Realty Income(NYSE: O) has an exceptional track record of increasing its dividend. The real estate investment trust (REIT) has raised its payment for 107 straight quarters (and 126 overall) since coming public in 1994. It has grown its monthly dividend at a solid 4.3% compound annual rate during that period.
One factor driving the REIT's steady dividend growth is its ability to continue expanding its portfolio. While higher interest rates have made it harder to find accretive equity investments, Realty Income has capitalized on the situation by starting to invest in real estate credit. That move could pay big dividends in the future.
Giving credit where credit is due
Realty Income made $805.8 million in new investments during the second quarter. The biggest one was a $377.5 million senior secured note issued by the parent company of U.K. grocer Asda. That credit investment has an 8.1% yield across its six-year term. That's a higher yield than the company will earn on real estate equity investments (7.9% average on acquisitions and 7.3% on development projects). The REIT capitalized on higher interest rates to lock in a high cash yield on a very stable credit investment.
That investment added to the company's growing credit platform, which it launched last year. Realty Income made its inaugural credit investment last August. It agreed to acquire a yield-bearing (8.1%) preferred equity interest in a joint venture (JV) with Blackstone's non-traded REIT, which owns The Bellagio Las Vegas. The REIT also made a $300 million common equity investment in that JV. The deal enabled Realty Income to make its second gaming property investment.
CEO Sumit Roy commented on the launch of its credit investment strategy in the press release unveiling the Bellagio investment: "Credit investments are a natural adjacency to our traditional business, allowing us to provide additional value to our clients while leveraging our core competencies in transaction sourcing and structuring, and real estate and credit underwriting and monitoring."
Realty Income made a total of $858.1 million in credit investments (real estate-backed loans and preferred equity investments) last year at an 8.7% yield. That rate was much higher than the initial yield it expects to earn from equity investments (7% on acquisitions and 6.8% for development projects).
Opening the door to future opportunities
Realty Income doesn't plan to become a mortgage REIT focused on credit investments. It's capitalizing on the current opportunity for these investments due to the rate environment. Roy discussed the company's credit strategy on the second-quarter conference call:
We intend to pursue credit investments selectively, and only when it may eventually facilitate access to high-quality real estate opportunities, as has been the case with Asda.We also believe these credit investments represent a profitable means for Realty Income to participate in and benefit from the current rate environment. Furthermore, from a risk management perspective, we view these credit investments as a prudent, natural hedge to the inherent rate exposure as we have on the liability side of our balance sheet.
The CEO highlighted three drivers of its credit investment strategy. First and foremost, it will help open the door to future real estate acquisition opportunities. For example, the company could eventually acquire its JV partner's interest in the Bellagio when it's ready to exit that asset. Meanwhile, it strengthened its relationship with Asda, its 11th-largest tenant. That could put the REIT in a better position to acquire additional properties from that partner via future sale-leaseback transactions.
Credit investments also enable the REIT to cash in on the currently lucrative environment thanks to higher rates. While higher rates have made it more challenging to find attractive equity investment opportunities, credit investments are enticing these days.
Finally, investing in credit while rates are high will help mitigate some of its exposure to higher future interest rates on maturing debt. In a sense, it can offset some of the impact of higher future borrowing costs because it's now locking in higher-yielding investments.
A smart strategy
Realty Income is a wise investor. The company focuses its efforts on finding investments that help grow its dividend. Right now, credit investments are very attractive, which is leading the REIT to focus on that strategy. It could pay big dividends in the future by providing it with lucrative income streams, new investment opportunities, and a hedge for its balance sheet. It's one of the many reasons why Realty Income is a great dividend stock to buy for the long term.
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Matt DiLallo has positions in Blackstone and Realty Income. The Motley Fool has positions in and recommends Blackstone and Realty Income. The Motley Fool has a disclosure policy.
