Patient investors look for safer stocks when the VIX begins to pop to protect their portfolio or expose themselves to high-quality assets at potential discounts. Realty Income (NYSE: O) could be one of those picks this cycle as a part of a real estate stock play.
A new cycle is about to start, this time sponsored by potential interest rate cuts coming from the Federal Reserve (the Fed), and money will likely shift into those sectors that have underperformed in the past year due to higher interest rates.
Realty Income could provide you with safety and a decent upside potential.
All the mechanics at play
Over the past 12 months, there has been a widening price-action gap between the Vanguard Real Estate ETF (NYSEARCA: VNQ) and the broader S&P 500.
Getting left behind by as much as 28.2% creates the potential for the sector to now catch up to the rest of the market in the new cycle.
According to the FedWatch tool at the CME Group (NASDAQ: CME), traders are pricing in that the Fed cuts will likely land in the economy by June or May of this year.
You can learn more in real time by following what investors like Warren Buffett have been interested in buying lately. It is no surprise that the Oracle of Omaha has been buying up stock in D.R. Horton Inc. (NYSE: DHI) and PulteGroup Inc. (NYSE: PHM) in the past quarters, expecting a construction boom.
You can read all about the reasons behind Buffett finding value in construction stocks if you're looking for safety and value.
When and if the Fed cuts interest rates, real estate is one of the sectors that typically tend to outperform the rest of the market, a trend you can see happening during 2020-2021, where Realty Income stock outperformed the S&P 500 by as much as 10%.
What’s the expectation?
Suppose you look at the recent past to understand the future. In that case, dissecting the recent rise in Simon Property Group (NYSE: SPG) stock can be the perfect example. Because interest rates would decline, markets became more understanding of companies that carried more debt on their balance sheet.
Debt makes up roughly 87% of Simon’s balance sheet. Understanding that not only real estate but also the retail consumer would benefit from the FED shift, markets bid up the price of the stock from roughly $100 a share up to $150, a 50% bump in just one quarter.
More than that, the dividend yield paid by Simon stock was nearly 7% back before the rally, making it a significantly attractive proposition during a time when the U.S. ten-year bond yields stood around 5%.
So, how does this set up the party for Realty Income stock? This company carries significantly less debt, at around 39.7% of its balance sheet, which means that markets could start rewarding companies that carry a lot less debt on them until rate cuts are more of a certain event.
A 6% dividend yield makes the stock a much better proposition than today’s ten-year bond yields, which only pay around 4.3%. If history repeats itself here, that superior yield alongside the better-managed debt could make Realty a prime suspect for investment dollars to find a new home.
You can check this thesis on how analysts currently feel about the two stocks. Assuming that the company had its run already, Simon analysts placed a price target of $137.80 a share, which shows a downside of 8.1% from today’s prices.
In contrast, Realty Income has earned its analyst love by commanding a price target of $61.50 a share, which directly implies the stock needs to rally by as much as 17.5% to meet that valuation.
