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Industrial Demand, Diversified Tenants to Aid Realty Income’s Q2

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Second-quarter expectations

Realty Income (O) is scheduled to report its financial results for the second quarter of 2018 on August 1. Wall Street anticipates the commercial and industrial rental property operator to post AFFO (adjusted funds from operations) of $0.79 per share, which suggests a YoY (year-over-year) growth of 5.3%. Revenue is expected to increase ~9% YoY and reach $327.43 million.

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Driving factors

Analysts seem to be backing their growth projection on rising demand and average rentals for industrial properties. According to a research report by Cushman & Wakefield, a commercial real estate services company, the US industrial market absorbed 56.9 million square feet in the first quarter, and vacancy rates came down to 5%, which is much lower than the ten-year historical average of 8.4%.

Improving domestic economy along with a strong jobs market and impressive consumer sentiment have spurred industrial activity in the United States, which is driving demand for rental space. That led to a 5.4% rise in industrial rents in Q1 2018. In its report, Cushman & Wakefield stated that there is no sign of demand slowing down, which means rental rates will most likely increase.

With 26 million square feet of leasable property for the industrial market, Realty Income must have benefited from the increased demand and rising rental rates. The company generates ~13% of its total revenues from renting industrial space.

Growth in tough retail environment

Realty Income’s well-diversified tenant base has also helped it sustain its growth momentum, even in the current challenging retail environment. The company generates ~81% of its total rental income from renting properties to retailers.

Its retail tenants are mainly comprised of non-discretionary tenants and service providers such as convenience stores, dollar stores, quick service restaurants, health and fitness companies, drug stores, and theaters. These businesses are less vulnerable to economic recession and face the least competition from e-commerce, which helps keep occupancy rates higher. In the first quarter, Realty Income’s occupancy rate increased 30 basis points YoY to 98.6%.

However, higher capital costs due to the company’s investment plan of acquiring properties between $1 billion and $1.5 billion in 2018 and rising interest rates may have a negative impact on its bottom-line results.

Peer estimates

Realty Income’s peers National Retail Properties (NNN), Macerich (MAC), and Brixmor Property Group (BRX) are expected to report AFFO per share of $0.66, $0.93, and $0.50, respectively. Realty Income and these competitors make up ~26% of the Pacer Benchmark Retail Real Estate SCTR ETF (RTL).

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