Down 12.5% in 2 Months, Is the Sell-Off in Realty Income a Buying Opportunity for Income Investors?

Realty Income's (NYSE: O) shares have hit a rough patch recently, dropping 12.5% over the last two months ended Oct. 9. The stock didn't fall in sympathy with the overall market, either. The S&P 500 index gained 1.1% during this period.

Realty Income's lagging stock price could signal bigger problems. Or this could present a buying opportunity based on short-term mispricing. How should income-oriented investors view the current situation?

A look at the business

Before making any investment decisions, it's important to understand Realty Income's business and industry. The company is a real estate investment trust (REIT), which owns or finances properties.

REITs have special appeal to dividend-seeking investors since they pay out the overwhelming majority of their earnings. In fact, to qualify as a REIT, companies must distribute at least 90% of their taxable income as dividends.

Realty Income, in existence since 1969, owns commercial properties, primarily retail. The company receives over 78% of its rent from retail properties.

It continues to have high occupancy, including 98.8% as of June 30, which has helped produce steadily improving results. Realty Income's adjusted funds from operations (FFO), an important metric for REITs since it measures cash available for distribution, grew 3.8% compared to a year ago.

Management raised its 2026 adjusted FFO guidance to $4.44 to $4.45 per share. That represents a 4% year-over-year increase.

However, Realty Income's results and stock price, like all REITs, are sensitive to rising interest rates. That's because investors become attracted to high bond yields. With inflation remaining elevated, the 10-year U.S. Treasury yield rose from 4.8% to 5.24% (as of Oct. 9) over the last two months.

Additionally, Realty Income has increased its debt to help fund its portfolio growth. Higher interest rates raise the company's borrowing costs.

Regular dividend increases

However, investors have come to expect regular dividend increases. Realty Income, which pays dividends monthly, raises them quarterly. In fact, it has increased payouts for 116 straight quarters and 136 times since the company's 1994 initial public offering.

Last month, the board of directors approved an increase from $0.271 to $0.2715. With the stock down sharply, Realty Income's dividend yield has increased to an attractive 6%. By comparison, the S&P 500 yields 1%.

Sometimes, a high dividend yield signals a cut is forthcoming. However, the payouts don't appear to be in danger. Annualizing the $0.2715 dividend, the $3.258 per share dividend is 73% of Realty Income's projected $4.44 adjusted funds from operations (FFO).

Making the investment call

Realty Income's long-term prospects remain solid. While higher bond yields may hurt results, they fluctuate and will undoubtedly go lower at some point.

Meanwhile, investors can lock in the stock's high dividend yield, making Realty Income's price drop a buying opportunity.

Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Realty Income. The Motley Fool has a disclosure policy.