To The Moon

$Realty Income(O)$

Realty Income's share price has dropped by 20% over the past three months, bringing it back to levels last seen at the lowest point of this bear market—even before the Federal Reserve began cutting interest rates. In total, Realty Income has now endured nearly five years of a bear market, with its share price trading 35% lower than pre-pandemic levels.

This decline comes despite the company increasing its cash flow by approximately 25% during the same period. Essentially, this means the company's valuation has plummeted by 60%, which can be described as a true market crash. I'll display a table comparing its current valuation to its historical average, highlighting how historically undervalued the stock is.

As a result of this discount, its dividend yield has risen significantly and now exceeds 6%—an exceptionally rare level for a REIT of this caliber. I'll also show a chart of its historical dividend yield, illustrating that it is currently higher than at any point in the past decade. Could this be the right time to invest in Realty Income while it remains deeply discounted?

With Realty Income currently trading at historically low valuations, now might be one of the best times to consider investing in this sector. The question remains, however: Is Realty Income a buy, hold, or sell at these levels? The answer largely hinges on your outlook for future long-term interest rates.

Realty Income, like many other REITs, has become highly sensitive to long-term interest rates. It's important to note that we're not just discussing the Federal Reserve's short-term funds rate, which has been reduced recently. Instead, we're focusing on long-term rates, such as the 10-year Treasury yield, which have been rising. This increase has created significant downward pressure on Realty Income's stock price due to the strong inverse correlation between REIT valuations and long-term rates.

This is especially true for Realty Income, given its heavy investment in net lease properties with long-term leases, fixed rent escalations, and what are classified as "long-duration assets." Such assets are particularly susceptible to changes in long-term interest rates.

If you believe long-term interest rates will decline, now could be an excellent time to buy Realty Income, as the stock would likely appreciate in such a scenario. On the other hand, if you think rates will remain elevated for an extended period, a hold rating may be more appropriate. Conversely, if you foresee long-term rates rising further—perhaps driven by another surge in inflation—it might be best to consider selling the stock.

In my view, long-term rates are more likely to decline, which is why I rate Realty Income as a buy at current levels. However, I am personally not purchasing Realty Income, as I prefer one of its close peers (to be discussed later). Nonetheless, I expect Realty Income to perform well over the coming years as interest rates gradually revert to lower levels.

Why do I anticipate lower long-term rates? In short, I believe the recent spike in inflation and interest rates was a temporary anomaly caused by the pandemic. As the global economy normalizes, I expect inflation and rates to return to their pre-pandemic trajectory. Pandemic-era factors such as stimulus checks, supply chain disruptions, and altered consumer behavior led to a temporary inflationary surge, forcing the Fed to implement aggressive rate hikes.

However, these factors were transitory. We are witnessing the reemergence of powerful disinflationary trends, which we call the "Five Horsemen": aging demographics, technology, over-leverage, globalization, and technological advances. These forces have driven inflation and interest rates lower for decades and remain as strong as ever today.

In fact, inflation has already returned to pre-pandemic levels. Adjusting for real-time shelter costs, inflation has been below 2% for the past 18 months. This decline has given the Fed confidence to cut interest rates, reducing them by approximately 100 basis points so far.

So why have long-term rates surged recently? Market volatility and growing uncertainty are key contributors. Recent geopolitical events and shifts in leadership—such as the election of Trump—have created turbulence, driving rates higher due to concerns about tariffs, trade disruptions, and other policy changes.

Tax cuts are often perceived as inflationary. Additionally, recent economic data has exceeded expectations, prompting the Federal Reserve to pause its interest rate cuts to ensure inflation remains under control. This pause has contributed to the rise in long-term interest rates in recent months, reflecting the uncertainty in the market.

To be fair, the short-term outlook is highly uncertain—no one can predict with complete confidence what will happen in the near term. However, I believe the long-term trajectory remains unchanged, driven by the strong economic forces I previously described as the "Five Horsemen." The bond market seems to share this view, with three-year forward inflation expectations hovering around 2%. The Fed also appears to align with this outlook, projecting interest rates to stabilize at approximately 3% by 2027.

While rate cuts in 2025 might be fewer than anticipated just six months ago, the longer-term expectation remains largely the same: interest rates returning to about 3%. If this materializes, long-term rates are likely to decline gradually over the next few years. This trend could accelerate if the economy weakens—something I see as a strong possibility, given that we are long overdue for a recession.

In this scenario, Realty Income could reprice significantly higher, which is why I currently rate it a buy. However, despite this positive outlook, I am personally waiting for better entry point to investing in Realty Income.

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