Should You Buy Realty Income Stock While It's Below $67?

Realty Income's (NYSE: O) stock closed at a record high of $67 on Aug. 15, 2022. Over the following year, rising interest rates caused the real estate investment trust (REIT) to sink to a three-year low of $43.67 on Oct. 30, 2023.

But over the past year, investors have warmed up to Realty Income again in anticipation of lower interest rates. The U.S. Federal Reserve finally cut its benchmark interest rate for the first time in four years in September, and its future rate cuts will likely drive more investors back toward REITs like Realty Income and other high-yielding dividend stocks.

That's why Realty Income's stock now trades at nearly $62 again. Should you buy it today before it revisits its all-time high?

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Why is Realty Income sensitive to interest rates?

Realty Income is an equity REIT that buys properties, rents them out, and splits the rental income with its investors. As a net lease REIT, its tenants are responsible for covering their own maintenance costs, property taxes, insurance fees, and other expenses. It's also required to pay out at least 90% of its taxable income as dividends to maintain a favorable tax rate.

When interest rates are low, it's easy for REITs to secure cheap financing to buy more properties. Their tenants will also face fewer macro headwinds, and lower rates make fixed income investments like CDs and T-bills less appealing than high-yield REITs and other dividend stocks.

But as interest rates rise, it becomes more expensive for REITs to purchase new properties. More of their tenants could shut down their businesses or abandon their leases, and higher rates will make risk-free CDs and T-bills more attractive to income investors than dividend stocks. That's why Realty Income's stock sank as interest rates rose.

Realty Income's strengths are becoming more apparent

Realty Income already owns 15,450 properties across the U.S., U.K., and Europe, and it leases them out to more than 1,500 tenants across 90 different industries. That makes it one of the world's largest and most broadly diversified REITs. It's kept its occupancy rate above 96% over the past three decades.

It's also one of the few REITs that pays out monthly dividends, and it's raised its payout 127 times since its IPO in 1994. It currently pays a forward dividend yield of 5.1% -- which is much higher than the 10-year Treasury's 4% yield.

REITs usually measure their profit growth through their funds from operations (FFO) per share instead of their earnings per share (EPS). From 2013 to 2023, Realty Income grew its adjusted FFO at a steady compound annual growth rate (CAGR) of 5.1%. And at its current price of $62, it still looks cheap at 16 times last year's adjusted FFO of $4 per share.

Will declining rates drive Realty Income's stock to new highs?

All of those strengths could propel Realty Income's stock to new heights as interest rates decline. But Walgreens and Dollar Tree -- its second- and third-largest tenants, respectively -- have both been closing down hundreds of stores to right-size their struggling businesses.

Those two retail tenants accounted for a combined 7.1% of Realty Income's annualized rent in 2023. Walgreens plans to close down about 8% of its stores, while Dollar Tree aims to shutter at least 12% of its Family Dollar stores.

That sounds like dire news, but Realty doesn't own all of those affected properties, and it still has plenty of time to find new tenants to replace Walgreens and Family Dollar as their leases expire. Its largest tenant, Dollar General, plans to open hundreds of new stores -- and that expansion could offset Walgreens' and Dollar Tree's issues.

Even if Realty Income's stock rises to $67, it would still be trading at 17 times last year's adjusted FFO and paying a forward yield of 4.7%. Therefore, lower interest rates could easily drive it back to its all-time highs and beyond in the near future.

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Leo Sun has positions in Realty Income. The Motley Fool has positions in and recommends Realty Income. The Motley Fool has a disclosure policy.