Inflation Surges: Is Realty Income Still a Safe Haven for Investors?

Inflation isn't just creeping—it's sprinting. And Realty Income investors are watching every tick.

The Yield Play Under Pressure

Rising prices hammer REITs harder than most assets. Dividend yields get crushed when inflation outpaces property income growth. Realty Income's famous monthly checks suddenly look less generous when consumer prices leap 5% annually.

Lease Structures vs. Economic Reality

Triple-net leases provide some insulation—tenants cover most expenses. But inflation eventually permeates every contract. Renewal negotiations become brutal battles over escalator clauses. Even recession-resistant tenants like dollar stores feel the squeeze when wholesale prices spike.

The Interest Rate Hammer

Fed hikes hit REITs with a double-whammy: higher borrowing costs and competition from suddenly attractive Treasury yields. Why chase 4% property dividends when risk-free bonds pay 5%? Realty Income's acquisition engine sputters when debt gets expensive.

The Silver Lining Playbook

Well-located commercial real estate historically outperforms during inflationary periods. Rents eventually reset higher. And let's be real—when has betting against American retail consumption ever worked long-term? Walmart isn't going bankrupt because milk costs more.

Final Tally: Worry, But Don't Panic

Inflation hurts, but it's not fatal. Realty Income's diversified portfolio and investment-grade balance sheet provide armor. The stock might wobble, but the underlying assets remain valuable. Though if you wanted predictable returns, maybe should've bought Treasury bonds instead of pretending REITs are 'safe' investments.

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Inflation could be a tailwind to Realty Income's real estate portfolio

REITs give investors the ability to invest in properties without having to acquire or manage them themselves. Realty Income operates using a net lease business model, which means that its tenants are generally responsible for most of the costs associated with the sites they occupy, including maintenance, utilities, insurance, and property taxes.

That puts Realty Income in a good spot, because it doesn't need to worry about how inflation may impact expenses it doesn't have to fund, as long as its tenants can still pay their rent. The company benefits as inflation increases the values of the properties it owns and allows it to boost its rents. Realty Income typically includes automatic inflation-driven rent escalators in its lease agreements.

Getting paid is the top priority for any landlord, and tenant quality is one of Realty Income's strengths. Its real estate portfolio is highly diversified, spanning 15,600 properties across the United States and Europe, and it largely caters to recession-resistant, retail-oriented tenants, like convenience store chains. Even when COVID-19 lockdowns froze the economy, Realty Income's same-store rent only contracted by 1.7%.

High interest rates could be a headwind

One potential problem that inflation could represent for Realty Income is that when inflation gets too high, the Federal Reserve tends to combat that by raising its benchmark interest rates and otherwise tightening its monetary policy. If rates are high, that raises Realty Income's borrowing costs. REITs distribute almost all of their taxable income to shareholders every year via dividends, so they often use debt to fund their purchases of new property.

Higher borrowing costs make it harder to financially justify such purchases, meaning slower growth for the REIT or a tighter spread between its cost of capital and the returns it generates. That's a jargon-filled way of saying that when interest rates rise, Realty Income might not be as profitable.

The good news is that Realty Income has historically managed to navigate less-friendly interest rate environments quite well.

Yields on 10-year U.S. Treasury notes heavily influence interest rates on corporate debt. The 10-year T-note's yield averaged 5% from 1996 to 2008. During that span, Realty Income's funds from operations (FFO) grew at an annualized rate of 5.2%. The 10-year yield averaged 2.3% from 2009 to 2022. During that span, Realty Income's FFO grew at an annualized rate of 5.4%.

So, dramatically lower rates (cheaper debt) didn't make all that much of a difference in how Realty Income's business performed.

Why Realty Income is a buy

Realty Income's track record indicates it is likely to handle a more inflationary environment just fine, barring anything extreme. Investors probably don't need to worry much.

That said, should investors buy the stock now? Its share price is roughly flat relative to where it was five years ago, despite its FFO per share increasing by over 20%. That makes Realty Income a fundamentally cheaper stock now. Today, shares trade at approximately 15 times FFO. Realty Income typically grows at a low single-digit percentage pace, so that low valuation is probably fair, at the very least, for the growth you'll likely get.

On top of that, the REIT does distribute a generous dividend that at current share prices yields 5.5%. It also has a roughly three-decade streak of annual dividend raises to its name. Investors can maximize their potential returns from this stock by reinvesting their dividends and letting the investment's growth compound over time. Just remember that due to their tax structure, REITs pay nonqualified dividends, so the government will tax them as ordinary income unless you keep them in a tax-advantaged account.