Could Agree Realty Become the Next Realty Income?

Realty Income (NYSE: O) is the 800-pound gorilla in the net lease sector, with a massive $50 billion market cap. It's four times larger than its next closest competitor, and more than six times the size of fast-growing peer Agree Realty (NYSE: ADC). Should Agree Realty be aiming to take Realty Income's place?

What does Realty Income do?

Like Agree Realty, Realty Income is a net lease real estate investment trust (REIT). Net lease properties are generally single tenant assets for which the tenant is responsible for most property-level expenses. While any individual building is a high risk because there's only one tenant, across a large enough portfolio the risk is fairly low. Realty Income owns over 15,400 properties, so individual property risk is also fairly low. Agree owns around 2,250 properties, which is a large portfolio -- just not quite as large as Realty Income's.

Both of these net lease REITs have a heavy focus on retail properties. Realty Income generates around 73% of its rents from this sector, while Agree Realty is focused solely on retail assets. There are a number of important takeaways from both the size difference and the fact that Realty Income's portfolio is spread beyond the retail sector.

Realty Income needs more levers

The retail niche of the net lease sector is probably among the most liquid areas in which a net lease REIT can invest. Realty Income estimates the size of the market in the United States at around $1.5 trillion. The properties are also small and, very often, similar, making them easy to buy, sell, and lease. There's ample room for Agree Realty to keep expanding, even though it has grown rapidly. To put a number on that growth, at the end of 2014, roughly a decade ago, Agree Realty owned just 209 properties. It has expanded quite aggressively, even though it still owns about 13,000 fewer properties than Realty Income.

That said, Realty Income's size is also a headwind. It is so large that it requires more investment activity to grow the business. In the third quarter of 2024, Agree Realty bought 66 properties, a number that would barely be a rounding error for Realty Income but is still quite significant for Agree Realty. That's where the problem arises. Buying properties is not an easy task, and while the U.S. retail net lease sector is large, it isn't big enough to supply Realty Income with all the deal flow it needs.

That's why the company generates nearly 30% of its rents from "other" assets, including industrial properties and some large one-off transactions, such as casinos and vineyards. It's also why Realty Income's portfolio has spread out to include European properties in addition to U.S. properties, and why the REIT recently announced that it was looking to build an asset management business. Realty Income simply needs more irons in the fire if it wants to grow. Even then, the growth is likely to be slower than what Agree Realty can achieve from its smaller base of assets.

Can Agree Realty grow to Realty Income's size?

The simple answer is: Yes, Agree Realty could become the next Realty Income... someday. But investors used to the rapid growth Agree Realty has offered probably shouldn't want that day to arrive too quickly. Notably, Agree Realty's dividend has increased at an annualized pace of around 6% over the past decade, while Realty Income's dividend growth has hovered closer to 3%.

Sure, Realty Income offers a larger 5.5% yield today, versus Agree Realty's 4%. But for dividend investors who favor dividend growth over yield, Agree Realty and its still material opportunity for expansion will probably be more attractive than slow and steady Realty Income for years to come.

Reuben Gregg Brewer has positions in Realty Income. The Motley Fool has positions in and recommends Realty Income. The Motley Fool has a disclosure policy.