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Realty Income (NYSE: O) is often considered a stable long-term investment for conservative income investors. It’s one of the world’s largest real estate investment trusts (REITs), and its tenants include large retailers like Walgreens, 7-Eleven, Dollar General, Dollar Tree, and Walmart. Many of those retailers are resistant to recessions, and some of them even thrive during economic downturns.

As a REIT, Realty Income is obligated to pay out at least 90% of its taxable earnings as dividends to its investors. And as a net lease REIT, its tenants are responsible for covering most of their own expenses — including maintenance costs, property taxes, and insurance fees. That simple business model enables the company to generate plenty of cash to cover its monthly dividend.

Despite all those strengths, Realty Income’s stock has declined 23% over the past two years as investors fretted over rising interest rates and some challenges for its top tenants. Nevertheless, I believe that pullback is a buying opportunity for five simple reasons.

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1. Interest rates could stabilize and decline

The Federal Reserve is widely expected to reduce interest rates over the next two years. That’s great news for Realty Income since high interest rates make it tougher to buy properties and make its dividends less attractive.

During Realty Income’s latest conference call in February, CEO Sumit Roy said the company expected the Fed to “start cutting” interest rates in “six to seven months.” Roy also said it would be “first in line to react” to those rate cuts.

Meanwhile, its declining stock price boosted its forward dividend yield to 5.7%. That’s higher than the 10-year Treasury’s 4.2% yield and most CD yields. That widening gap should drive more income investors back to the REIT.

2. Store closure fears are overblown

Realty Income’s three largest tenants are Dollar General, Walgreens, and Dollar Tree (which also owns Family Dollar). Those three tenants accounted for 3.8%, 3.8%, and 3.3%, respectively, of its annualized rent in 2023. That’s why it was alarming when two of those retailers started closing hundreds of stores. Walgreens plans to close up to 700 stores in the U.S., while Dollar Tree plans to shutter 970 of its Family Dollar stores.

But that’s only about 8% of Walgreens’ stores and 12% of Family Dollar’s stores — and Realty Income doesn’t own all those properties. If we do the math, those gradual closures should only impact a sliver of Realty Income’s rental income from those two tenants.

That’s significant, but its other major tenant, Dollar General, could offset some of the pressure by opening 800 new stores this year. Those store closures will also occur in multi-year phases as the leases expire — so Realty Income should still have plenty of time to replace those tenants and maintain its high occupancy rate.

3. A high occupancy rate and healthy FFO growth

Realty Income ended 2023 with a high occupancy rate of 98.6%, and that ratio has never dropped below 96% over the past three decades. It recently expanded its portfolio by merging with Spirit Realty and now owns 15,450 properties.

Realty Income’s adjusted funds from operations (FFO) rose at a compound annual growth rate (CAGR) of 25% from 2018 to 2023, even as the pandemic and inflationary headwinds rattled many of its top tenants. Its adjusted FFO per share — which is a clearer metric for a REIT’s growth than its earnings per share (EPS) — increased at a CAGR of 5%.

4. Plenty of room for dividend hikes

Realty Income has paid consecutive monthly dividends ever since its founding in 1969. It’s also raised its dividends a whopping 124 times since its public debut in 1994.

It only paid out 71% of its free cash flow (FCF) over the past 12 months — so it still has plenty of room to raise its monthly dividends. That makes it a great stock for dividend growth investors to buy and hold.

5. It’s historically cheap

Realty Income might initially look expensive with a price-to-earnings ratio of 43, but REITs are usually valued relative to their FFO per share. By that metric, the stock looks historically cheap at just 13 times the company’s adjusted FFO per share in 2023.

Back when Realty Income hit its all-time high of $68.54 on Aug. 15, 2022, it was trading at 17 times its adjusted FFO for 2022. Therefore, it makes sense for investors to buy the stock right now while the near-term concerns about interest rates and the store closures at Walgreens and Family Dollar are still compressing its valuation.

Should you invest $1,000 in Realty Income right now?

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Leo Sun has positions in Realty Income. The Motley Fool has positions in and recommends Realty Income and Walmart. The Motley Fool has a disclosure policy.

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