VNQ - Realty Income Vs. Agree Realty: Which Is The Better REIT To Buy Today?

2023-10-27 08:05:00 ET

Summary

• Realty Income Corporation is probably the most famous REIT in the world.
• Agree Realty Corporation is a similar REIT, but it is not nearly as popular.
• Which one is the better REIT to buy today? We reach a firm conclusion.

Realty Income Corporation ( O ) is the biggest and most popular net lease real estate investment trust, or REIT, in the world.

Agree Realty Corporation ( ADC ) is a smaller and up-and-coming net lease REIT that's similar to Realty Income.

• They both focus on class A net lease properties, often occupied by investment-grade tenants.
• They both have strong investment-grade rated balance sheets.
• They both have long track records of market outperformance.
• They both pay dividends on a monthly basis.
• And they have both recently crashed and are now offered at historically low valuations and high dividend yields.

But which one is the better investment opportunity now?

Seems to me that a lot of investors are favoring Realty Income because of its superior past performance. Realty Income has handily outperformed Agree Realty since going public - generating about 50% higher total returns:

Moreover, Realty Income has a better dividend track record . It has managed to grow it for nearly 30 years, whereas Agree Realty was forced to cut it following the great financial crisis. Back then, ADC was a much smaller REIT and it was heavily concentrated on one tenant called Borders that filed for bankruptcy, forcing ADC to rework its portfolio.

So it may seem on the surface that Realty Income is a better investment.

After all, it has managed to generate higher total returns with lower risk and more consistent dividend payments over the past ~30 years.

But here's the thing:

There's this famous saying that "past performance is not indicative of future results" - and this applies particularly well here.

If you shorten your time frame and look at the more recent past, you will see that ADC has generated far higher returns than Realty Income - all while also growing its dividend at a faster pace:

And I don't think that ADC's outperformance will end anytime soon.

The reason why ADC is performing so much better is that O has become too big for its own good and lost its mojo in a way.

To understand why this matters, you need to recognize that net lease REITs like O and ADC generate most of their growth by acquiring additional properties.

Therefore, the bigger you are, the harder it becomes to grow.

It means that you will have to acquire a lot more properties, but there are only so many properties for sale at any given time. This then forces you to step out of your circle of competence and invest in new property sectors (like casinos , let's say...) and geographies in which you may not be an expert.

On the other hand, if you are small in size, each new acquisition has a much greater impact on your bottom line and you can afford to be more selective, only buying the best properties that you come across.

Well, ADC and O are both very similar in terms of their portfolio, balance sheet, and management quality, but the big difference is that ADC is 7x smaller in size:

This is a big deal.

It means that every new investment that ADC makes has a 7x larger impact on its bottom line.

Put differently, O needs to find 7 more properties to acquire to achieve the same external growth rate.

That's a tough job, and this is the primary reason why I would expect ADC to outperform going forward.

I would add that ADC also enjoys many other advantages. I summarize them in the table below:

The ground lease component is especially attractive and not getting enough attention in my opinion. Ground leases offer a lower initial yield, but they are far safer and when the lease expires, the building reverts back to the landowner - here ADC - at no additional cost, allowing the landlord to push for large rent hikes. Today, the average remaining lease term on these ground leases is just 11 years so this should create a lot of value to ADC shareholders over the coming decade.

The flip side of things is that O is now a bit cheaper than ADC, but all things considered, this is well justified and the difference is really not significant.

ADC expects to grow its FFO per share by 3% in 2023, whereas O has guided to grow it by 2%. Given what we discussed earlier, we think that ADC will keep growing faster than O for a long to come, leading to higher total returns for its shareholders.

Bottom Line

I am bullish on both O and ADC.

But if I had to pick one, it would be Agree Realty Corporation, because ADC will likely earn higher total returns and enjoy faster dividend growth over the long run.

For further details see: