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High-Yield REITs: Resilience Amid Market Uncertainty

August 11, 2024

Note: We reveal investment insights through the quotes of top business leaders.

Key Takeaways

  • High-yield REITs like Realty Income are achieving strong performance with an 8.1% yield and a projected 10% operational return for 2024.
  • Higher interest rates have increased interest income but also raised interest expenses, impacting the cost of capital for REITs.
  • Sector-specific trends show a focus on disciplined growth, high-quality property acquisitions, and managing operational costs to mitigate risks.
  • Realty Income leverages top-tier credit research and asset management to navigate market uncertainties and optimize value.
  • The company strategically diversifies investments, including data centers in Spain, and avoids obsolete investments, showcasing resilience compared to other options.

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Current performance of high-yield REITs

High-yield REITs like Realty Income are demonstrating strong performance, with investments yielding 8.1% and a projected operational return profile of approximately 10% for 2024. This includes a 6% anticipated dividend yield and 4.3% AFFO per share growth, despite some uncertainty around future dividend levels.

"That end, the six year £300 million sterling senior secure loan we invested in during the quarter provides us with an attractive 8.1% yield secured by the solid credit of a U.K. grocery store operator, while reducing the rate sensitivity on the value of sterling debt we have on the balance sheet maturing in 2030, which currently totals £540 million. From a 2024 earnings guidance perspective, we are reiterating our full year investments at $3 billion in our AFFO per share guidance of $4.15 to $4.21, which represents 4.5% annual per share growth, assuming the midpoint." --- (O, earning call, 2024/Q2)

"Jonathan Pong: Thank you, Sumit. It's been a quiet start to the year on the capital markets front, following our January US dollar bond offering, which raised $1.25 billion in gross proceeds at a blended yield to maturity of approximately 5.14%." --- (O, earning call, 2024/Q1)

"Although we expect to continue our policy of paying monthly dividends, we cannot guarantee that we will maintain our current level of dividends, that we will continue our pattern of increasing dividends per share, or what our actual dividend yield will be in any future period." --- (O, sec filing, 2024/Q2)

"In particular, AFFO provides an additional measure to compare the operating performance of different REITs without having to account for differing depreciation assumptions and other unique revenue and expense items which are not pertinent to measuring a particular company’s on-going operating performance." --- (O, sec filing, 2024/Q1)

"Our projected 2024 operational return profile of approximately 10%, which comprises an anticipated dividend yield close to 6% and AFFO per share growth of approximately 4.3%, assuming the midpoint of guidance is a validation of our value proposition." --- (O, earning call, 2024/Q1)

Impact of interest rates on high-yield REITs

Higher interest rates have led to increased interest income from cash, loans, and preferred equity investments for high-yield REITs like Realty Income, boosting other revenue. However, they also resulted in higher interest expenses due to increased average debt and weighted average interest rates, impacting the cost of capital.

"The increase of $3.1 million and $5.8 million for the three and six months ended June 30, 2024 as compared with the same periods in 2023, respectively, is primarily due to an increase in interest earned on cash and cash equivalents attributable to higher rates and average balances." --- (O, sec filing, 2024/Q2)

"Other revenue increased by $30.8 million and $64.0 million for the three and six months ended June 30, 2024 as compared with the same periods in 2023, respectively, primarily due to an increase of $24.0 million and $44.1 million from interest income earned on loans and preferred equity investments for the three and six months ended June 30, 2024, respectively, in addition to higher interest income on financing receivables of $6.3 million and $18.9 million for three and six months ended June 30, 2024, respectively, driven by an increase in recent sale-leaseback transactions with above-market lease terms." --- (O, sec filing, 2024/Q2)

"The increase in other revenue for the three months ended March 31, 2024 as compared with the same period in 2023 is primarily due to higher interest income on financing receivables of $12.6 million driven by an increase in recent sale-leaseback transactions with above-market lease terms, in addition to an increase of $20.4 million from interest income earned on loans and preferred equity investments." --- (O, sec filing, 2024/Q1)

"Average outstanding balances $ 24,663,786 $ 18,658,173 Weighted average interest rates 4.03 % 3.59 % The increase in interest expense for the three months ended March 31, 2024 as compared with the same period in 2023 is primarily due to higher average debt and weighted average interest." --- (O, sec filing, 2024/Q1)

"And the added element that's taking place is there's a little bit more clarity today, and I say that and I smile as to where the interest rates are going to go, and so obviously, the cost of capital side of the equation has changed for a lot of the REITs." --- (O, earning call, 2024/Q2)

High-yield REITs are focusing on disciplined growth, acquiring high-quality properties, and managing operational costs. Market conditions impact real estate values, making historical depreciation less informative. This strategic approach aims to mitigate risks and capitalize on emerging opportunities, reflecting sector-specific trends in resilience and adaptability.

"Property expenses (reimbursable) decreased by $7.2 million and increased by $6.0 million for the three and six months ended June 30, 2024 as compared with the same periods in 2023, respectively, consistent with changes in our contractually obligated reimbursements billed." --- (O, sec filing, 2024/Q2)

"Haendel St. Juste: Hey, good morning out there. Sumit, you mentioned thoughtful and disciplined growth selective a few times about your prepared remarks, clearly suggesting that the activity will remain subdued as you push the more yield and quality, but you did leave the door open in capacity in the gas a little bit more compelling opportunities to emerge in the back half of the year." --- (O, earning call, 2024/Q1)

"Since real estate values historically rise and fall with market conditions, presentations of operating results for a REIT using historical accounting for depreciation could be less informative." --- (O, press release, 2024/05/06)

"This long-term oriented underwriting model is what drives our focus on acquiring high-quality real estate, leased to solid operators who are leaders in their respective industries, because we believe these opportunities have significantly lower residual risk -- value risk." --- (O, earning call, 2024/Q1)

"Since real estate values historically rise and fall with market conditions, presentations of operating results for a REIT, using historical accounting for depreciation, could be less informative." --- (O, sec filing, 2024/Q1)

Management strategies amid market uncertainty

Realty Income leverages top-tier credit research and asset management teams to navigate market uncertainty, optimizing value even amid store closures and varying credit scenarios.

"And then we overlay the credit on top of that. And then asset management goes through those and tries to create various different areas of what is the economic outcome going to look like under, for instance, a client that may not have any credit issues will pay rent. But at the end, this asset may not have other alternatives available to it outside of a vacant sale." --- (O, earning call, 2024/Q2)

"Managing through periodic store closures is a natural part of our business model, and our top-tier credit research and asset management teams offer distinct competitive advantages, which have consistently enabled us to optimize value in these situations. To that end, we would like to provide remarks on a few clients that are currently managing through store closures or have been in the news due to credit-related concerns." --- (O, earning call, 2024/Q2)

Comparative analysis with other investment options

Realty Income Corporation strategically leverages credit investments opportunistically, diversifies into data centers in Spain, and explores development opportunities in large cities. Despite facing refinancing challenges, the company emphasizes avoiding obsolete investments, showcasing a resilient and adaptive approach compared to other investment options.

"Thanks. Sumit Roy: So Haendel, yes, the last comment you made is accurate. We are not anticipating doing any credit investments in the second half but just to be very clear, credit investments is something that we have used opportunistically in the past, and we will continue to use opportunistically going forward." --- (O, earning call, 2024/Q2)

"There are other opportunities that we are looking at. We do have an investment that we will make, we will continue to make in Spain, that is also looking at a data center side that we believe is very well located, and there seems to be a lot of interest in that particular side." --- (O, earning call, 2024/Q1)

"We've obviously made two investments. It represents slightly north of 3% of our rents and we are in conversations with other opportunities, including potential development opportunities in large cities." --- (O, earning call, 2024/Q1)

"And that continues to be how we think about our credit investment. But one of the advantages of doing this Wes, as I'm sure you recognize is this continuous headwinds that we experienced, given the refinancings that we are having to incur at much higher rates." --- (O, earning call, 2024/Q1)

"And I think that was one of the lessons that this particular sector had to learn the hard way when they went through renewals and they were taking write-downs in space. But outside of that, make sure that things that can become obsolete are investments that we would want the operator to make. And we stay as close and as true to the" --- (O, earning call, 2024/Q2)

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