Rate Cuts: 1 High Yield Dividend Stock to Buy Now

The Federal Reserve’s recent announcement of a 50 basis point interest rate cut is a big deal. It marks the long-awaited easing cycle after the Fed aggressively raised rates to fight inflation in 2022. Interest rates affect almost everything in the economy, dictating the cost of borrowing money for businesses and consumers.

Real estate income (A 0.40%) it was a market behind high rates, but it may soon come off the page now that rates are coming down. With lower rates, Realty Income could especially appeal to yield-hungry investors.

Here’s why Realty Income likely has brighter days ahead, and why, with falling rates on the move, the stock is an instant buy.

Why income from real estate appears at lower rates

Realty Income shares didn’t even wait until the Fed’s official rate cut announcement. It has been unfolding since July, when weaker-than-expected inflation data sparked market speculation that the Fed would soon consider cutting interest rates. Why did real estate income take off at the mere thought of rate cuts?

It all comes down to the cost of borrowing money. Realty Income is a real estate investment trust (REIT), a company that buys and leases real estate. REITs pay no income tax, but must distribute at least 90% of their income to shareholders. Because REITs must return so much of their profits to shareholders, they generally use debt and equity to finance acquisitions and grow the company.

REITs increase their intrinsic value when they earn a higher return on their capital (debt or equity issued) than it costs.

Higher interest rates make debt more expensive, narrowing that gap and hindering the value Real Estate Income creates when borrowing and investing for growth. So why did Realty earnings jump at the first sign of a rate cut? Because Realty Income’s businesses should perform much better in a cheaper loan environment.

Hungry for income? Feast on this dividend

Following the recent cut, the federal funds rate is 4.75% to 5.00%, and financial vehicles such as high-yield savings accounts will have a lower yield. Retirees and other income-seeking investors will look to alternatives like dividend stocks for income. And when it comes to high-yield stocks, Realty Income is a true blue chip.

Realty Income boasts a portfolio of over 15,000 commercial properties. Primarily, it leases to recession-proof single-tenant businesses such as grocery, convenience and dollar stores, pharmacies, auto service centers and restaurants. The company has increased its dividend for 31 consecutive years, a streak that has withstood the most severe economic crises in recent history, such as the Great Recession of 2008-2009 and COVID-19 in 2020.

The dividend remains mathematically sound. Management is providing about $4.20 per share in funds from operations (FFO) this year, easily enough to cover the $3.16 it pays out in total annual dividends. Real estate yields around 5% despite stocks trading near 52-week highs, and that yield will only stand out more if the Fed continues to cut rates.

Real estate income is still a purchase

The stock’s dividend might be reason enough for some investors to buy Real Estate Income, but the stock is still a good value overall. I measure Realty Income’s earnings using cash from operations as a proxy for FFO, a non-GAAP measurement standard in the REIT industry.

Today, Realty Income trades at about 15 times cash from operations, which is still at the lower end of its range over the past decade. Below, you can see how the highest federal funds rate in a decade pushed stocks to their lowest valuation.

O CFO price per share (TTM) data by YCharts.

Now that’s relaxing. It’s hard to say how high real estate valuations could go, because no one knows how low they’ll go now that the Fed has started tapering. However, you can see that the stock could realistically trade at 20 times cash from operations or higher if rates fall enough.

Investors looking for a margin of safety could play the middle ground and buy the stock while it trades below 18 times Realty Income’s cash from operations. That makes the stock a great option for investors looking for income today.