Realty Income(NYSE: O) has done a magnificent job growing its portfolio, cash flow, and dividend since coming public 30 years ago. It has grown into the world’s eighth largest real estate investment trust (REIT), with nearly $58 billion in real estate. Meanwhile, it has increased its dividend every single year, including for the last 108 quarters in a row.
The REIT believes it has a lot more growth ahead. One factor driving that view is that it’s only tapping into a small fraction of the capital invested in the commercial real estate market. That’s about to change, opening the door to even more growth potential in the coming years.
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“Access to capital is paramount to the success of our company,” stated Realty Income CFO Jonathan Pong on the third-quarter conference call. The REIT needs to be able to borrow money and issue equity at a reasonable cost of capital to make accretive acquisitions. Over the years, the company has consistently obtained well-priced capital from the public market thanks to its portfolio size, scale, and diversification. That has enabled it to grow by capitalizing on high-quality investment opportunities.
Thanks to its elite balance sheet, Realty Income has greater access to public capital than most REITs. It’s one of only eight REITs in the S&P 500 with two bond ratings of A3/A- or better. That consistently enables it to access low-cost capital. For example, it was recently able to issue $500 million of notes due in 2054 with an effective yield to maturity of 5.5%. It also completed a public non-U.S. bond offering at a low average yield to maturity of 5.4%. With cap rates on new real estate investments averaging 7.4% in the most recent quarter, Realty Income can make highly accretive deals.
There’s an abundance of capital floating around in the public markets that Realty Income can tap in the future to continue growing its portfolio. However, there’s even more capital available in the private marketplace. That has led the REIT to evaluate ways to tap this massive opportunity.
On the call, CEO Sumit Roy highlighted the size of the private capital markets:
The amount of equity available from private sources far exceeds thatwhich is available through the public markets we have traditionally accessed. The size of the U.S. private real estate market is approximately $18.8 trillion, 10 times larger than the $1.9 trillion of assets owned by public REITs. Thus, private capital controls more than 90% of the U.S. commercial real estate market based on research from the National Association of Real Estate Investment Trusts.
The private real estate market comprises institutional investors (e.g., pension funds, sovereign wealth funds, endowments, foundations, and large insurance companies) and high-net-worth or retail investors owning commercial real estate outside of publicly traded investment vehicles. Realty Income wants to tap into this massive pool of capital to enhance its ability to grow in the future.
Specifically, “our intent is to create and operate an evergreen open-end fund that will manage private capital on behalf of institutional investors,” stated Roy on the call. The REIT plans to be a meaningful co-investor in the fund, enabling it to generate additional income from its investment. In addition, it will receive fees for managing the fund and potentially earn incentive fees. “These additional earnings would bolster Realty Income’s return on investment,” noted Roy.
The CEO continued, “We expect this initiative to enhance our ability to grow our earnings and dividend, expand our addressable market for investments, and reduce our reliance on public equity across market cycles when strategically advantageous.” This new fund will also enable the REIT to “source, acquire, and manage a larger percentage of available market opportunities than we currently acquire for the public vehicle.” While Realty Income has greater access to capital than most REITs, capital is a limiting factor. So it routinely passes on accretive investment opportunities. For example, it has sourced $34 billion of potential investment opportunities this year. However, it has only closed $2.1 billion of transactions or 6% of its sourced volume. By accessing the much larger private capital market, Realty Income can close additional accretive deals, enhancing its scale and growth rate.
Realty Income wants to dive into a much deeper pool of capital by tapping into the private marketplace. This strategy will enable the REIT to make even more future acquisitions, enhancing its growth rate and providing management fee income. That should allow it to grow its dividend even faster in the future, further enhancing its appeal to income-seeking investors.
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