Realty Income Corp : 3 Questions About Its Recent Buys
Real estate investment trusts are always buying or selling something. This week, Realty Income Corp announced that it acquired $503 million in new properties in the third quarter.
The press release is light on details, leaving me with three important questions:
1. Why are yields stuck at 7%?
Even though the 10-year risk-free rate has surged since a May 2013 bottom, Realty Income's newly acquired property yields have barely budged. This quarter, Realty Income announced a 7.1% initial yield on new acquisitions, compared to 7% in the second quarter, and 7.9% in the first quarter of 2013.
Realty Income's ability to consistently grow its dividend is hinged on its success in finding high-yielding properties that it can fund with lower-cost debt and equity financing. While it's too early to say that yields are stuck at 7%, investors should hope that Realty Income's acquisition pipeline provides the company higher yields given rates are now higher than they were just months ago.
2. What's the mix?
We'll know more about Realty Income's portfolio when it reports earnings, but one big question is who's paying the leases?
Realty Income has slowly acquired more and more higher-yield, but less attractive warehouse properties, which offer investors a smaller margin of safety than single-tenant retail property. It's worth noting that John Case, the former Chief Investment Officer, is now in place as CEO. As new deals flow through the pipeline, investors will have to watch carefully to see if a management changes results in a different acquisition strategy.
The company's portfolio mix doesn't shift significantly quarter to quarter, but if it continues on a quest to acquire warehouse properties, it may turn off shareholders who like retail exposure.
3. Who are the tenants?
Realty Income has made smart moves to divest from properties that may be challenged in a weak economic environment. In the last year, for example, it has tried to diversify from higher-priced "fast-casual" eateries, noting that a payroll tax increase in 2013 might crimple traffic at some stores.
The company announced that 72% of its expected revenue from newly acquired properties would come from investment-grade tenants. In the last quarterly filing, Realty Income estimated that 38% of rental revenue came from investment-grade companies. This leads me to ask, is the mix shift in the last quarter evidence that Realty Income is seeking higher quality but less profitable real estate?
The Foolish bottom line
Rarely can you make an investment decision based on a single quarter, but following a company's progress is a great way to tune into its vital signs. As the quarterly earnings report nears, keep an eye on Realty Income's shifting sources of revenue for new trends in tenant selection and property type. I'll be digging through the report the second it hits the SEC.
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The article Realty Income Corp : 3 Questions About Its Recent Buys originally appeared on Fool.com.Fool contributor Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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