Is Realty Income A Good Real Estate Stock Pick For 2023? (NYSE:O)

Elevator Pitch

I upgrade my investment rating for Realty Income Corporation (NYSE:O) from a Hold to a Buy.

I previously wrote about Realty Income Corporation’s share price correction in September with my earlier article published on October 3, 2022. In this latest write-up, my focus is on Realty Income Corporation’s 2023 prospects and its attractiveness as a potential investment candidate.

My analysis leads me to the conclusion that analysts and investors don’t have very high expectations of Realty Income Corporation’s potential financial and stock price performance in 2023. But I think that the market’s view of Realty Income Corporation will change for the better, when catalysts such as above-expectations organic and inorganic growth for O in 2023 are realized. Therefore, I see Realty Income Corporation as a good real estate pick worthy of a Buy rating.

O Stock Key Metrics

There are three positive takeaways relating to the key metrics that were disclosed as part of O’s most recent Q3 2022 financial results press release.

Firstly, Realty Income Corporation delivered reasonably good rent recapture rates of 108.5% and 106.7% for the Q3 2022 and 9M 2022 time periods, respectively. In contrast, O’s rent recapture rates were much lower at 100.0% and 103.4% for full-year FY 2020 and FY 2021, respectively as indicated in its third quarter results presentation.

Realty Income Corporation has been successful at creating value with its re-leasing activities, and this is reflected in its metrics like rent recapture rate. Looking forward, O mentioned at its recent third quarter results briefing that it expects to still “be north of 100% in terms of recapture rate” for “the next six to eight months.”

Secondly, the portfolio occupancy rate for O remained high at 98.9% as of September 30, 2022. As a comparison, Realty Income Corporation’s end-Q2 2022 and end-Q3 2021 portfolio occupancy rates were 98.9% and 98.8%, respectively.

Also, Realty Income Corporation has guided for its 2022 portfolio occupancy rate to stay above 98%. It is noteworthy that the portfolio occupancy rate for O has always exceeded 97.9% for every year between 2013 and 2021. Even during the worst of the 2008-2009 Global Financial Crisis, Realty Income Corporation’s annual portfolio occupancy rate has never dropped below 96.6%.

Thirdly, Realty Income Corporation increased the mid-point of its fiscal 2022 normalized FFO (Funds From Operations) guidance by +3% from $3.905 to $4.030. O also narrowed its FY 2022 AFFO (Adjusted Funds From Operations) guidance from $3.84-$3.97 to $3.87-$3.94.

At its Q3 2022 results call, O emphasized that its “continued stable and consistent results” for the most recent quarter gave it the confidence to raise normalized FFO forecasts and offer a narrower AFFO guidance for full-year fiscal 2022.

In the next section of this article, I detail the market’s expectations of Realty Income Corporation’s 2023 financial performance.

What Is The Forecast For 2023?

Wall Street analysts expect that Realty Income Corporation will achieve decent financial results for FY 2023, although O’s performance next year isn’t expected to be as good as it was in FY 2022.

O’s AFFO growth is projected to moderate from +8.5% for fiscal 2022 to +2.9% in fiscal 2023, based on the consensus financial numbers taken from S&P Capital IQ. The sell-side analysts also forecast that Realty Income Corporation’s dividends per share will increase by +2.9% in FY 2023, which represents a slower pace of growth as compared to O’s +4.8% dividend per share hike for FY 2022.

What Do Analysts Believe About Realty Income?

The market’s reasonably low expectations of Realty Incorporation for 2023 are also reflected in the change in the consensus price targets for O in recent months.

In the past two and a half months, the mean target price for Realty Income Corporation has been cut by -9% from $77.03 as of September 30, 2022 to $69.94 as of December 12, 2022 as per S&P Capital IQ data. Similarly, O’s median sell-side price target was reduced by -8% from $76.50 to $70.00 during the same period.

I highlight the key re-rating catalysts for Realty Income Corporation in the subsequent section of the current article.

What Are Realty Income Catalysts To Watch For?

Realty Income Corporation’s key catalysts to watch for are better than expected organic and inorganic growth for the REIT in 2023. As discussed in the preceding section, analysts have rather modest expectations of O’s dividend and AFFO growth in the following year.

With respect to organic growth, investors are worried that the weak macroeconomic environment will hurt the rental rates and occupancies of Realty Income Corporation’s existing properties. But O is much more defensive and resilient than what one would expect.

O revealed at its Q3 2022 investor briefing that “less than 4% of our contractual base rent comes due” by the end of next year, and highlighted that “properties leased to clients in our portfolio watch list represented less than 4%” of its yearly rent. Separately, Realty Income Corporation disclosed in its recent quarterly results presentation that 78% and 14% of its annual rent are derived from “non-discretionary” retail and “non-retail” tenants, respectively. In other words, economic pressures and e-commerce disruption threats are relatively less of a headwind for O.

Also, Realty Income Corporation has achieved good success in re-leasing its properties to generate a high rent recapture rate in recent quarters, as mentioned in an earlier section of the article. There is no reason to doubt that O can continue to realize value from re-leasing activities in 2023.

In terms of inorganic growth, Realty Income Corporation’s prospects relating to acquisitions appear to be pretty decent.

One factor is sale-leaseback.

At the beginning of this month, O announced that it concluded the “$1.7 Billion sale-leaseback of Encore Boston Harbor” deal with Wynn Resorts (WYNN). Moving ahead, sale-leaseback transactions are likely to continue being a major source of Realty Income Corporation’s acquisition volume in the next year.

Realty Income Corporation noted at its most recent quarterly investor call that “institutional owners of real estate were far more willing to enter into sale leaseback as an alternative source of raising capital.” This means that there could be upside to O’s actual acquisition volume in 2023 thanks to a larger-than-expected increase in sale-leaseback transactions.

Another factor is the environment for acquisitions has become more favorable, and O has an edge in competing for deals.

Realty Income Corporation’s acquisition cap rate has expanded by +40 basis points from 5.7% in Q2 2022 to 6.1% for Q3 2022. As noted in a June 30, 2022 First American (FAF) commentary, rising cap rates “mean sellers will need to reduce their price expectations”, and this is positive for acquirors like O.

Separately, Realty Income Corporation highlighted at its third quarter results call that its “cost of capital has held up” relatively well as compared to its peers. O also stressed that this is the REIT’s “biggest advantage” in a market where there is a lack of “potential buyers being able to write large checks.” It is reasonable to assume that Realty Income Corporation is in a more favorable position to compete for M&A targets as compared to its smaller peers with weaker financial profiles.

In summary, investors will be more willing to re-rate Realty Income Corporation’s shares going forward, when O’s 2023 organic growth and inorganic growth performance surprise the market in a positive manner.

Is O Stock A Buy, Sell, or Hold?

I have O’s stock rated as a Buy now. I am of the view that Realty Income’s actual FY 2023 financial performance should turn out to be better than what the current consensus numbers suggest.