Realty Income Stock Could Soar 20%, According to a Wall Street Analyst. Is It a Buy Now?

If you're looking for businesses that can deliver a reliable stream of passive income, it's hard to go wrong with real estate investment trusts, or REITs. Shares of these specialized entities trade on public markets like regular stocks, but there's an important difference. REITs can avoid paying income taxes by distributing nearly all of their profit to investors as dividend payments.

Heightened economic uncertainty has pushed shares of one of the largest publicly traded REITs, Realty Income (NYSE: O), down about 12% from a peak it reached last fall. Despite macroeconomic challenges, Stifel Nicolaus analyst Simon Yarmak recently maintained his buy rating on the stock.

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Yarmak also raised his bank's price target for the stock to $68 from $65.50 per share. The new target implies a gain of 20% from the stock's closing price on May 9. Let's weigh Realty Income's strengths against some challenges it faces to see if this could be a smart addition to your income-generating portfolio.

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Reasons to buy Realty Income now

Since acquiring a single Taco Bell restaurant in 1970, Realty Income has focused on providing monthly payments that grow steadily. To ensure predictability, it employs long-term net leases that transfer all the variable costs of building ownership, such as maintenance and taxes, to the tenant.

It's hard to find a more reliable dividend grower. This REIT has raised its monthly payout every quarter since becoming a publicly traded company in 1994.

At recently depressed prices, Realty Income offers an attractive 5.7% yield that has grown at an average annual rate above 3% over the past decade. An enormous portfolio that already contains 15,627 commercial real estate properties makes explosive dividend growth an unrealistic expectation. With annual rent raises written into long-term leases, though, decades of steady gains seem likely.

Realty Income seeks a diverse tenant roster. At the end of March, its three largest clients, 7-Eleven, Dollar General, and Walgreens, were responsible for 9.9% of total annualized rent.

In the 21st century, occupancy of Realty Income's property portfolio dipped below 97% from 2009 through 2012. Otherwise, it's been above 98%, and this reliability hasn't gone unnoticed by credit rating agencies. With an A3 rating from Moody's and an A- rating from S&P Global, Realty Income can borrow at interest rates that its smaller, less established competitors can only dream about.

Realty Income's portfolio is large, but there's still room to grow. It estimates the global addressable market for net lease REITs at a whopping $14 trillion. Publicly traded REITs account for less than 4% of the addressable market in the U.S. and less than 0.1% of the EU's addressable market.

Reasons to remain cautious

REIT stocks provide relatively safe yields, but they can't hold a candle to Treasuries backed by the U.S. government. As a result, REIT share prices tend to fall when rising interest rates also push up Treasury yields.

On April 2, the Trump administration raised taxes on imported goods, and the higher prices could cause inflation to spike again. The Federal Reserve likes a buoyant stock market as much as the rest of us, but it has a mandate to keep inflation low. If tariff-driven inflation rears its ugly head again, investors can expect another round of interest rate raises that could make REIT stocks less attractive.

The past several years have been lousy ones for at least two of Realty Income's largest tenants. Annualized operating income at Dollar General has fallen by more than half since 2021. Walgreens is losing so much money that it recently sold to a private equity firm for $10 billion. That's less than one-tenth of the peak its market cap reached about a decade ago.

A buy now

The best thing about owning REITs that employ net leases is that you generally don't need to concern yourself with their tenants' performance. With rent raises written into long-term leases, the cash flows that Realty Income records are the same if its tenants succeed or merely scrape by.

With a size advantage and a large addressable market, there's a very good chance the 5.7% yield this stock offers now will continue climbing by more than 3% annually for decades to come. Adding it to a diverse portfolio now to hold indefinitely is the right move for most income-seeking investors.

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Cory Renauer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Moody's, Realty Income, and S&P Global. The Motley Fool has a disclosure policy.