Is Realty Income The Best Retail REIT to Buy?

Since going public in 1994, Realty Income Corp O has produced phenomenal shareholder returns. Realty Income's 15.2% compounded annual return reflects management's prudent use of debt and equity capital to acquire single-tenant properties at attractive cap rates, exceeding the cost of capital.

This dividend stalwart has stellar past performance. Yet there are reasons to believe that other retail REITs are better positioned for future outperformance given their more attractive valuations. 

Realty Income's Portfolio: Realty Income's diversified portfolio consists of more than 6,600 properties. The company's properties are leased to approximately 600 clients within 56 industries among all 50 states. In the last several years, Realty Income has also made moves to enter foreign markets with their $2.2-billion U.K. portfolio. 

The biggest long-term threat to retail real estate is the rise of e-commerce, which continues to take up a growing share of total retail sales. To mitigate this, Realty Income has sought tenants with minimal risk to the pressures of e-commerce, such as convenience stores, dollar stores, grocery stores and home improvement retail.

Management estimates 96% of its tenants are e-commerce resilient. 

Realty Income Vs. Agree Realty: When investors are debating the best retail REITs, the top names often consist of the largest and most heavily and widely followed companies. Take Realty Income and Agree Realty Corporation ADC, for example. 

Realty Income's tenant base consists of a modestly smaller investment-grade tenant base relative to Agree Realty. While just 50% of Realty Income’s tenants are investment grade, Agree said 67% of its tenants are investment grade.

From a tenant quality perspective, Agree outperforms Realty Income. Having such a higher quality portfolio would warrant a higher multiple for Agree.

Realty Income’s P/FFO multiple is 20.9. Agree’s P/FFO multiple is modestly higher at 22.6.

Agree has slightly better future growth prospects to compensate for its better outlook, given Agree Realty’s expected four-year FFO per share growth is 7%, just above Realty Income’s 6.6% expected growth rate. 

The long-term performance of Agree and Realty Income should be very similar, making it difficult to generate excess returns in the stocks.

The same concept holds true for other net lease retail REITs, such as National Retail Properties, Inc. NNN and Essential Properties Realty Trust Inc EPRT, given their similar portfolios and high valuation multiples. 

Value Small-Cap REITs: The real value among retail REITs exists among value small caps. Two such companies that are extremely attractive at current prices include Alpine Income Property Trust Inc PINE and CTO Realty Growth Inc CTO.

Both companies are interrelated. Alpine is externally managed by CTO Realty, and CTO has been selling many of its single-tenant retail properties to Alpine over the last year.

While Alpine owns a portfolio of mostly single tenant retail properties, CTO is in the process of transitioning to a pure-play, multi-tenant shopping center REIT. 

Alpine’s P/FFO multiple for the year 2020 is 15.9.

Alpine is a very small REIT with significant external growth potential. After accounting for recent and expected acquisitions, Alpine is expected to generate $1.50 per share in FFO for 2021, resulting in a P/FFO multiple of 13.1.

Similarly, CTO Realty is guiding for FFO per share of $3.95 at the midpoint for 2021, resulting in a P/FFO multiple of 13.9.

Likewise, Alpine and CTO both have dividend yields of 5.1% and 7.2%, respectively. Such high yields are much greater than the 3.6% and 4.1% dividend yields offered by Realty Income and Agree.

The Final Word: While Realty Income appears primed to continue its streak of generating favorable risk-adjusted returns, its peers offer much more compelling valuations and potential for future returns.

Investors can buy these smaller REITs at significant discounts and higher dividend yield and income potential to the more heavily followed and promoted retail REITs.