Prediction: Realty Income's Data Center Pivot Will Supercharge Its Dividend Growth Over the Next Decade

Realty Income (NYSE: O) has been an extraordinarily consistent dividend stock over the years. The real estate investment trust (REIT) has increased its monthly dividend 135 times since its public market listing in 1994, including the last 115 consecutive quarters. The REIT has grown its payout at a healthy 4.1% compound average annual rate during that period.

While its dividend growth rate has slowed in recent years (1.8% year-over-year in the first quarter), I predict it will accelerate over the coming decade. One catalyst is the REIT's pivot to data centers. Given the massive investment opportunity in the space, it could supercharge Realty Income's growth.

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Partnering to build a platform

Realty Income made its inaugural investment in the data center space in late 2023 by forming a built-to-suit data center development joint venture (JV) with leading data center REIT Digital Realty (NYSE: DLR). Realty Income initially invested $200 million to acquire an 80% interest in the JV, which was building two data centers in Northern Virginia. The partners are funding their pro rata share of the remaining $150 million in development costs (80% Realty Income and 20% Digital Realty). Digital Realty had already pre-leased 100% of the capacity to a high-quality tenant under a 10-year term with 2% annual rent escalators. The tenant has the option to expand the capacity from 16 megawatts (MW) to 48 MW, which would increase the budget to $800 million.

That investment got Realty Income in on the ground floor of the data center sector, with a top-notch partner, offering built-in growth from lease escalations and expansion opportunities. The REIT is now taking another step to build out its data center investment platform by forming a strategic JV with Cloud Capital and a global institutional investor to invest in hyperscale data centers. It intends to invest in a diversified portfolio of stabilized hyperscale data centers leased to high-quality tenants under triple-net leases with 15 to 20-year terms across the U.S. and Europe.

Realty Income initially expects to invest up to $1.4 billion in the JV, funding it over time, with initial investments of $700 million to be made in the second and third quarters of this year. As part of the deal, Realty Income will acquire a 45% interest in the first asset, a stabilized hyperscale data center in Northern Virginia. It will also acquire similar interests in two other data centers under development in the future. The REIT can invest more money in the future on qualifying data center developments and acquisitions in the U.S. and Europe.

A large and growing investment opportunity

Realty Income has been steadily diversifying its portfolio over the years to expand its investable universe. It entered the data center segment in 2023 because they represented a large ($500 billion in the U.S.) and growing market opportunity.

That opportunity set appears poised to grow significantly over the coming decade. Hossein Fateh, the founder and CEO of Cloud Capital, stated in the JV announcement press release that "hyperscale customers need infrastructure delivered at unprecedented scale and pace." That's providing Cloud Capital and Realty Income with the opportunity to invest capital at scale to capitalize on this massive opportunity. According to an estimate by McKinsey, the world will need to spend $1.5 trillion on data centers built to handle traditional IT applications by 2030 and another $5.2 trillion on those capable of handling AI applications. It's a massive capital investment that companies can't fund on their own, which is why they're turning to third-party capital providers, such as institutional investors and REITs, to help fund the build-out. Given the massive data center capital needs, Realty Income should have plenty of opportunities to continue investing in the sector over the coming decade.

This pivot should pay big dividends over the coming decade

Realty Income is forming another partnership to invest in data centers. That's enabling it to invest more capital in this massive, rapidly expanding sector. I expect that these and future data center investments will accelerate the REIT's growth in the coming decade, positioning it to deliver faster dividend growth. That makes it a top dividend stock to buy and hold long term, as Realty Income should deliver strong dividend growth and total returns over the next decade.

Matt DiLallo has positions in Digital Realty Trust and Realty Income. The Motley Fool has positions in and recommends Digital Realty Trust and Realty Income. The Motley Fool has a disclosure policy.