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How Realty Income Corp (O). Makes Money

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Source: Realty Income annual report.

Realty Income Corp (NYSE:O) is a popular stock for dividend investors. But do you know exactly what you’re getting into when you buy shares of this REIT? Here’s the beginner’s guide to how Realty Income Corp (NYSE:O) creates returns for its investors.

Realty Income Corp (NYSE:O)

Leasing in a nutshell
As a triple-net REIT, Realty Income Corp (NYSE:O) specializes in leasing contracts that place the burden of property maintenance, insurance, and taxes on its tenants (97.7% of its leases are triple-net leases). The net-lease model allows it to have an extremely lean operation — the company employs only 104 people to manage more than 3,500 properties.

You might be thinking that, since Realty Income Corp (NYSE:O) doesn’t offer the full management services of other REITs, it must be losing out on customers, right? Not exactly. While some tenants may prefer that a leasing company manage a leased building, Realty Income Corp (NYSE:O) has other advantages that attract long-term tenants:

  1. Scale, which allows it to raise capital for real estate investments at a lower interest rate than its tenants.
  2. An investor base that likes real estate investments — unlike its tenants’ shareholders, who may not want real estate on their companies’ balance sheets.
  3. A geographically diverse portfolio that makes Realty Income a one-stop shop for customers who want to open many new locations simultaneously.
  4. A big balance sheet for sale-leaseback transactions, wherein companies sell property to Realty Income Corp (NYSE:O), then subsequently sign a long-term lease on the building from its new owner.

The company takes a very involved position in its real estate investments, asking its tenants to provide location-specific data on sales to ensure that it knows about any potential default or contract termination ahead of time.

Its top customers include household names like FedEx, LA Fitness, Walgreen, Family Dollar, and AMC Theaters.

Looking under the hood of the real estate portfolio
Realty Income’s massive portfolio of real estate investments focuses on stand-alone retail buildings, differentiating it from office and industrial REITs.

As of its June 30 earnings report, 77.7% of Realty Income’s revenue came from retail stores, 11.7% from distribution centers, and 5.3% from office buildings located in 49 U.S. states and Puerto Rico. The company prefers retail buildings because they’re located in high-traffic areas, and demand a premium price per square foot compared to other types of real estate. Also, because retailers invest heavily in marketing their location, they are less likely to move to save money on rental payments. Thus, many of Realty Income’s leases are renewed, even after their initial 10- and 20-year contracts expire.

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