Even with interest rates above 5%, I’m not looking to keep my excess cash in savings. With enough to meet my needs, I think dividend stocks are a better choice for earning passive income.
One that I’ve been buying regularly – and intend to keep buying is Realty Income (NYSE:O). The stock had has a great track record of increasing its dividend and I expect this to continue.
A Dividend Aristocrat
Realty Income is a real estate investment trust (REIT). It owns and leases a collection of retail properties, distributing rent as dividends to shareholders on a monthly basis.
At the moment, the stock comes with a 5.25% dividend yield. But UK investors should note that withholding tax will bring this down to around 4.45% – even in a Stocks and Shares ISA.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
The company has grown its distributions annually for over 25 years, making it a Dividend Aristocrat, (actually, it’s done better than that – increases have come every three months).
As a REIT, keeping this going will depend on intelligent use of debt. And with rising interest rates, that might be more challenging going forward than it has been before.
Growth
One of the key features of Realty Income is the quality of its tenant base. The company focuses on leasing to companies with strong balance sheets and good credit ratings.
The downside to this is that it makes rent increases more difficult to negotiate. Tenants that are unlikely to get into difficulties have more bargaining power than those in riskier positions.
On the plus side though, Realty Income’s approach leads to high occupancy ratings and strong rent collection metrics. This gives it good earnings visibility and a good credit rating as a result.
This is key for offsetting the risk of rising interest rates, making debt a problem. Reliable earnings allow the company to borrow with confidence and at relatively reasonable interest rates.
Compounding
Dividend growth at Realty Income has been steady, rather than spectacular, over the last decade. So I think reinvesting the monthly distritbutions to buy more shares is key.
Investing £10,000 today would buy 215 shares and generate £37 in passive income next month. That’s not life-changing, but reinvesting this over time could turn it into something substantial.
If the dividend yield stays at 4.5%, using the dividends from my initial £10,000 to buy more shares could result in a portfolio yielding £56 per month after 10 years. And things can kick on from there.
Compounding at that rate could take my annual income to £996 after 20 years and £1,491 after 30. And that’s not including the quarterly dividend increases the company has managed since 1998.
The key to great returns
In my view, the best way to earn passive income through the stock market is by starting early and letting the returns grow over time. This requires a company with a durable business model.
I think Realty Income fits the bill here, which is why I own the stock in my own portfolio. The company’s focus on quality tenants has yielded consistent growth and I expect this to continue.
That’s why I’d rather own 215 Realty Income shares than keep £10,000 in excess savings. Over the long term, I think this could be a great passive income investment.
