Real Estate Income: Europe and the Final Countdown to Rate Cuts (NYSE:O)

In our last coverage of real estate income (NYSE:O) pointed out that investors were better set up after an 8-year drought. We went through two different long term scenarios at the extremes and felt it was hard to see them as a bad investment no matter what happened.

This would create a fantastic return profile with reinvested dividends. We think this is a good investment for long-term holders as long as they keep their long time horizons and modest expectations. We are upgrading to a Buy Here.

Source: 8 year return drought

This worked and the stock practically flew as if it had changed its name to “Realty AIncome”. We look at recent results and the market price of rate cuts to tell you where we stand.

Q2-2024

Realty Income beat Q2-2024 estimates easy, but the amount seemed to be related to the timing of funds from operations (FFO). The REIT kept its guidance unchanged for the year.

Analysts also yawned and did not rush us to change their estimates.

This was despite significantly lower interest rates and credit spreads being in place compared to its initial guidance. It’s likely that some of the bears they talked about in the headwinds are playing out in the background as Realty Income sells underperforming properties or those where there is a huge risk of vacation going forward. You generally don’t see the damage from this in a direct way, but the high cap rates (low prices) for these properties tend to offset the growth numbers to some degree.

Europe

One of the big themes for Property Income has been the push into Europe over the past few years. A long time ago, it was often mentioned as a positive that Realty Income’s revenue was concentrated exclusively in the US. But the bulls have started to embrace the transatlantic capital flow, and frankly, they have no choice. Realty Income is really pressing its edge there, with two-thirds of Q2-2024 capital going there.

It’s quite interesting to see that Realty Income shows several trillion dollar opportunities in Europe.

He even went through the trouble of showing how exactly this benefits both parties, the buyer and the buyer (Real Estate Income in this case).

An interesting thing to note here is that the REIT does share buybacks in its model. Obviously, this means that the counterparty is being talked about as a publicly traded company. If you understand this part, then you can also understand why. European companies can afford to sell their properties for a relatively higher cap rate on sale-leaseback transactions because their inventories are cheap. We can show that part in the following graph.

So that’s a pretty interesting dynamic that Realty Income is tapping into, and one that we don’t see changing unless US stocks tumble 50% or more. On the contrary, we can see that if European stocks have a huge market. But in any case, Europe remains the game for now.

The final count

The Federal Reserve has embraced the idea of ​​cutting interest rates, with markets at record highs and inflation remaining well above its own targets. All that remains to be done is to offer the 200 basis points of rate cuts at which rates are priced.

To the extent this remains consistent with an immaculate soft landing, it will support a higher valuation for Property Income. We see no problem revaluing the stock at a multiple of 17X if something like this pans out. After all, we have much lower quality REITs like Iron Mountain Incorporated ( IRM ) that trade for exactly twice as much. Of course, the only real soft landing we had after a barrage of rate hikes was in 1994, and at that time the yield curve never inverted.

So it remains to be seen whether we can achieve this.

Verdict

If the rate cut cycles prove to be too late to prevent a recession, there are again downside risks for the company. Alternatively, we may not see the full extent of interest rate cuts priced in as inflation resets to a higher base and begins to move upward again. The stock looks pretty well priced here for what it’s offering and it’s certainly not dirt cheap since it was only 3 months ago. We move this to a “Hold” and believe there are better real estate stocks to speculate on over the medium term.

Realty Income Corporation 6% PFD SER A (NYSE: O.PR)

If the rate cut forecasts are correct, then O.PR is slightly undervalued. It is likely to be redeemed if Fed Funds move lower by 200 basis points and we have a soft landing. Realty Income hates preferred stock, and that comes because of its acquisition of Spirit Realty Capital. We just don’t own it because we went Rexford Industrial Realty, Inc. for a long time. 5.875% PFD SER B (REXR.PR.B). That one had a higher yield at the time (and still does) and also had more tie advantage (and still does). We rate O.PR as a hold, but it’s a low-risk play for those who believe in all these rate cuts.

Please note that this is not financial advice. It may seem, it sounds, but surprisingly, it is not. Investors are expected to do their own due diligence and consult a professional who knows their goals and constraints.