Real estate investment trusts (i.e., "REITs") (VNQ) are a popular choice for income-seeking investors, offering reliable dividends and the potential for long-term growth. Both Realty Income (NYSE:O) and NNN REIT (NYSE:NNN) are particularly popular with dividend growth REIT investors due to their:
- High dividend yields
- Battle-tested and highly defensive triple net lease business models
- Investment grade credit ratings
- Very impressive dividend growth and total return track records as both are Dividend Aristocrats and have beaten the total returns generated by the S&P 500 (SPY) over the long term:
In this article, we will compare their business models, balance sheets, dividend outlooks, and valuations, and share our opinion on which is the better buy today.
O Stock Vs. NNN Stock: Business Models
O and NNN both operate as net lease REITs, which means they own and lease real estate properties, primarily to retail and commercial tenants. However, there are differences in their specific business models.
Realty Income is often referred to as "The Monthly Dividend Company" because of its impressive track record of paying monthly dividends for decades. The company owns a vast portfolio of retail and commercial properties, primarily single-tenant buildings, across various sectors. Realty Income's business strategy revolves around long-term leases with tenants, typically spanning 10 to 20 years. This approach provides a predictable and stable stream of rental income for the company.
One notable aspect of Realty Income's portfolio is its diversification across industries and geographical locations. The REIT operates without relying on malls or strip centers, focusing on single-tenant, freestanding properties. This strategy helps minimize exposure to e-commerce risks and ensures consistently high occupancy rates.
Specifically, it boasts a vast portfolio of 12,237 commercial real estate properties, serving 1,240 clients spanning 84 diverse industries. Operating across all 50 states of the U.S., as well as Puerto Rico, Italy, Spain, and the U.K., Realty Income's conservatively structured triple net lease business model solidifies its cash flow stability. Furthermore, its defensive position is reinforced by key metrics, such as approximately 41% of its rent being sourced from investment-grade clients and an impressive 92% of total rent coming from tenants that are considered recession and/or e-commerce-resistant.
Realty Income's reputation as a "SWAN" (Sleep Well at Night) stock stems from its ability to weather various economic cycles, as demonstrated by its uninterrupted monthly dividend payments through the Great Financial Crisis and COVID-19 lockdowns.
NNN REIT is another formidable net lease REIT with a different operational approach. The company boasts a remarkable track record of 33 consecutive years of dividend increases, highlighting its dedication to consistent income distribution.
NNN primarily invests in retail properties, concentrating on freestanding single-tenant buildings while avoiding malls and strip centers. Their tenant portfolio showcases both geographic and sector diversification, with a stronger presence in the South, Midwest, and Southeast regions.
One standout feature of NNN is its exceptional occupancy rate, which consistently outperforms the industry average. In fact, the company has never experienced an occupancy rate below 96.4%. The leases in its portfolio have conservative expiration schedules, with less than 4.5% expiring through 2024 and over 55% not expiring until after 2031. This ensures a steady and reliable stream of rental income. While not as large as O's portfolio, NNN still has ~3,500 properties in its portfolio, giving it plenty of diversification.
Both Realty Income and NNN have exhibited resilience in challenging economic conditions, proving their reliability as income-generating investments.
O Stock Vs. NNN Stock: Balance Sheets
Realty Income has maintained a strong and stable balance sheet over the years. The company holds investment-grade credit ratings from both S&P Global and Moody's, indicating a solid financial foundation. Moreover, its A- credit rating from S&P is one of the highest in the entire REIT sector.
NNN REIT has also maintained a robust balance sheet. NNN is rated as a BBB+ REIT, which is just a little bit worse than O's.
Both companies' financial strength is illustrated by their well-laddered debt maturities, which should help mitigate some of the headwinds that they may feel from rising interest rates. Moreover, their strong credit ratings enable them to raise debt at fairly attractive rates. For example, NNN recently raised 10-year debt at a 5.905% interest rate, which is only about a 140 basis point premium to the 10-year U.S. treasury yield.
O Stock Vs. NNN Stock: Dividend Outlooks
Realty Income's long streak of monthly dividend payments have earned it the reputation of a reliable income generator. While the REIT has historically achieved an annual FFO (Funds from Operations) growth rate of approximately 5%, it's essential to note that this growth is expected to slow down to around 4% in the current economic environment given that it only has limited ability to issue new equity given that its stock price is trading at a discount to its underlying net asset value. This means that its growth will entirely come from its reinvested retained AFFO, which typically only accounts for less than a quarter of cash flow as well as its contractual rental increases on its leases, which typically range from 1 to 2%.
The company's payout ratio, which measures the proportion of adjusted funds from operations distributed as dividends, typically remains below 80% and this year is expected to come in at ~76%. This conservative payout ratio reflects Realty Income's commitment to maintaining dividend sustainability even during challenging times.
Assuming it earns a levered yield of ~10% on its reinvested cash flow and averages 1.5% in contractual rent bumps, O should achieve ~4% in AFFO per share growth for the foreseeable future. That said, there will be some headwinds from interest rate expense increasing as maturing debt needs to be refinanced, so O's growth rate is more likely to come in at ~3%. If it keeps its dividend payout ratio constant over that period, its dividend per share should grow at the same pace.
While the dividend growth rate may not quite be as high as in the past, Realty Income remains an attractive option for income-seeking investors due to its impressive track record and commitment to growing its dividend payments over time.
National Retail Properties also boasts an impressive dividend history, with 33 consecutive years of dividend increases. The company has consistently outperformed the industry average in terms of occupancy, which further strengthens its position as a dividend-focused investment.
NNN's dividend payout ratio is also conservative, usually remaining below 70% and in 2023 its AFFO payout ratio is expected to come in at 68.5%. This level of conservatism ensures that the company can continue to provide a reliable income stream to its shareholders while also retaining plenty of cash flow flexibility to be able to invest opportunistically into new properties.
Meanwhile, NNN's average annual rent escalators are a bit stronger than O's given that it invests in more niche counterparties who do not generally have quite as strong of credit ratings, thereby enabling them to command better lease terms. As a result, its average rent escalator is 1.8% instead of 1.5%. When combined with its greater retained cash flow, NNN should be able to grow its AFFO and dividend per share at a 5% rate moving forward, which is 25% faster than O's expected growth rate. That said, there will be some headwinds from interest rate expense increasing as maturing debt needs to be refinanced, so NNN's growth rate is more likely to come in at ~4%.
Assuming the Federal Reserve is successful in keeping inflation rates at least somewhat close to its long-term 2% target, both O and NNN provide an attractive combination of current yield and dividend growth that exceeds the inflation rate, providing real purchasing power growth over time.
O Stock Vs. NNN Stock: Valuation
Realty Income trades at a 0.86x P/NAV multiple, indicating a steep discount to its underlying real estate. Moreover, its P/FFO multiple of around 12.22x and P/AFFO multiple of 12.54x both indicate that O is trading at a large discount to its five year averages of ~18.18x and 18.26x, respectively. Finally, its NTM dividend yield of 6.1% looks highly compelling when combined with the expected ~3% growth moving forward, even compared to current interest rates.
NNN, meanwhile, looks even cheaper when compared to O. It trades at a 0.82x P/NAV multiple, indicating a slightly steeper discount to its underlying real estate. Moreover, its P/FFO multiple of around 11.02x and P/AFFO multiple of 10.93x both indicate that NNN is trading at a large discount to its five-year averages of ~15.73x and 15.45x, respectively. Finally, its NTM dividend yield of 6.3% looks highly compelling when combined with the expected ~4% growth moving forward.
Investor Takeaway
Both O and NNN offer investors very attractive risk-adjusted returns, as their yield plus growth rates look to offer 9-10% total returns with very low risk. Moreover, the steep discounts to NAV and well-diversified portfolios of in-demand real estate imply that the long-term downside is limited, particularly with interest rates likely near their peak in this cycle. In fact, both could see 10-20% multiple expansion in the coming years once the Federal Reserve pivots to interest rate cuts. As a result, potential double-digit annualized total returns alongside low risk make O and NNN some of the best risk-adjusted investments possible right now given that we are on the verge of a likely economic downturn and face a lot of geopolitical uncertainty.
While we like both, we slightly prefer NNN given its greater growth potential with only a very slight incremental risk relative to O. That said, investors who want to minimize risk as much as possible and strongly prefer monthly dividend checks may like O more than NNN.
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