Where Will Realty Income Stock Be in 5 Years?

Realty Income (NYSE: O) has a strong performance history over the long run, with cumulative returns since its 1994 IPO that have handily outpaced the S&P 500 (SNPINDEX: ^GSPC). However, over the past decade, the net lease real estate investment trust, or REIT, has significantly underperformed the broader market.

Of course, some of this has been due to the surge in megacap tech stocks largely fueling the S&P 500's performance during that time. But even so, a 108% total return in a decade (about 7.6% annualized) is lower than long-term investors tend to hope for from their stock investments.

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Having said that, Realty Income hasn't underperformed due to anything being wrong with the business itself. Its properties are still generating predictable, growing income streams. Management is still finding ways to invest billions in capital per year into new investments. And the company's bottom line continues to grow, allowing management to keep increasing the dividend, with the current streak standing at 111 consecutive quarterly dividend raises.

Image source: Getty Images.

Realty Income's business is doing well

As of the first quarter, Realty Income owns 15,627 properties, and about 73% of its rental income comes from retail tenants. Portfolio occupancy was 98.5%, and although nearly 200 leases matured, Realty Income managed to recapture about 104% of the prior rent. Adjusted funds from operations (AFFO), the best metric for real estate "earnings," grew by 3% year over year despite the difficult interest rate environment.

During the quarter, Realty Income managed to deploy $1.4 billion in acquisitions at an average initial yield of 7.5%, and about 60% of new investment activity was in Europe. Management expects to spend a total of $4 billion this year on investments, and it wouldn't be surprising to see the actual total be more. Because of its excellent corporate credit, Realty Income recently issued new debt at a 5.125% interest rate, so the economics of acquiring new properties still make a lot of sense.

Also, keep in mind that Realty Income is designed to perform well, no matter what the economy or stock market does. Tenants are on long-term, triple net leases, which are great for revenue visibility and have gradual increases built in. Cash flow has been extremely stable in a variety of environments -- in fact, even in the initial wave of the COVID-19 pandemic in 2020 (when many of its tenants literally couldn't operate), Realty Income's occupancy never declined by even one percentage point from prior highs.

Where will Realty Income stock be in five years?

Where Realty Income's stock will be in five years will largely depend on the interest rate environment. I mentioned that the company has produced mildly disappointing returns over the past decade, but we've had not one but two rising-rate environments in that time, and the benchmark federal funds rate is more than 400 basis points higher than it was a decade ago.

Therefore, if interest rates generally gravitate lower over the next few years and are significantly lower in five years than they are now, Realty Income's stock is likely to outperform the broader market. On the other hand, if the interest rate environment is comparable to where it is now, or rates end up moving higher, the opposite could be true, and we could see the same thing we've seen in recent years: total returns that are still in the mid-to-high single digits, but lower than the overall market.

However, regardless of what interest rates do, I feel far more confident in predicting where Realty Income's business will be in five years than its stock price. In all likelihood, the company's portfolio will remain more than 98% occupied, and the portfolio will continue to grow, with several billion dollars invested each year. After all, there is a multitrillion-dollar investable universe of properties in the company's target verticals.

I also foresee European properties making up a significantly higher percentage of the total five years from now. And I also believe that regardless of what the stock price does, Realty Income's dividend will be about 20% higher than it is now, as it has historically grown by about 4% annually.

Realty Income has been one of my largest investments for more than a decade, and it's one I plan to keep for decades to come. I'm confident that the stock will produce excellent total returns between now and when I plan to retire in about 20 years, during which time we should see several different interest rate environments. However, any given five-year period is much less certain.

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Matt Frankel has positions in Realty Income. The Motley Fool has positions in and recommends Realty Income. The Motley Fool has a disclosure policy.