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Morningstar | Acquisitions Lead to a First-Quarter Beat for Realty Income

First-quarter results for Realty Income came in slightly ahead of our expectations due to the company executing more external growth at higher-than-anticipated cap rates in the quarter. While our bottom-line estimates for 2019 might come up, we don't anticipate making any material changes to our $59 fair value estimate for the no-moat rated company, given that we don't think that it can sustain economic profits from external growth over the long term. Occupancy dipped 30 basis points sequentially to 98.3%, below our 98.6% estimate. However, contractual rent grew 1.1% and releasing spreads were up 4.7%, slightly ahead of our 1.0% rent growth and 3.4% releasing spread assumptions, leading to net operating income growth of 1.5% that beat our 0.9% estimate. Realty Income executed on $519 million in acquisitions at a 6.7% cap rate, ahead of our $450 million at 6.25% cap rate assumptions. The extra income generated by the company's first-quarter acquisitions led to Realty Income beating our adjusted fund from operations estimate by a penny with a $0.82 number in the first quarter. However, we will note that the acquisitions included fewer investment-grade tenants than the overall portfolio (31% compared with 38% overall), so Realty Income is making a slight sacrifice in quality for the extra income.

In addition to the first-quarter acquisitions, Realty Income also announced that it is acquiring a portfolio of 12 properties in the U.K. for $557 million. Whereas the first-quarter acquisitions were at a high cap rate but lower quality, this is a high-quality portfolio but executed at a low 5.31% cap rate. While we typically favor buying quality, this seems like a full price to pay and the reduction in risk from the quality of the assets is offset by the fact that it puts Realty Income into an international market in which they have no previous experience.