Realty Income‘s (NYSE:O) an incredibly popular stock with investors looking for a second income. And with monthly dividends and an outstanding track record, it’s easy to see why.
A 5.3% dividend yield’s also nothing to take lightly. But I think UK investors need to be a little bit wary of some of the hidden costs that come with investing in this type of asset.
Reliability
Realty Income’s a real estate investment trust (REIT) that owns a portfolio of properties mostly in the retail sector. And the company’s theme is reliability.
The firm specialises in securing long-term contracts with reliable tenants, which minimises the risk of rent defaults. On top of this triple-net leases mean rising maintenance costs are limited.
One downside to this is that it also limits the scope for increasing rents, meaning Realty Income has to buy and sell properties to generate growth. But it’s done this very well in the past.
There’s nothing at all wrong with focusing on resilience first and foremost and the company has increased its dividend every quarter for more than 25 years. Over time, that growth adds up.
Dividends
Realty Income currently pays $0.27 (around 24p) per share in monthly dividends. At today’s exchange rates, it looks as though the number of shares needed for a £1,000 a month second income is 4,692.
There is however, a catch. As a UK investor, dividends I receive from US companies are subject to a 15% withholding tax (30% for investors who don’t fill out a W-8BEN form). That means the actual number of shares I need to target that £1,000 a month in dividends is more like 5,536. And that’s quite a significant difference from an investment perspective.
With the stock trading at $61 per share, that’s the difference between $286,212 (£213,556) and $337,696 (£251,971). In other words – I’ll need an extra £40,000 over time to offset those taxes.
Staying closer to home
I’m not in a position to make that kind of an investment right now. But these are the kind of calculations that UK investors need to make when thinking about their long-term returns.
Dividends from US companies come with a 15% withholding tax and a Stocks and Shares ISA can’t get you around this. And that kind of drag on returns is something to take seriously.
It’s also worth noting that a number of UK REITs come with attractive yields at the moment. They don’t typically pay monthly dividends, but they trade at lower valuation multiples. This is something that private equity investors have been looking to take advantage of in the last couple of years. But I think there are still some opportunities that are worth considering.
Maximising returns
There’s a lot to like about Realty Income. In terms of passive income, it might well be one of the highest-quality businesses available on the stock market right now.
Investing however, is about more than finding good companies. Investors also need to think about valuation and how much of their expected return they’ll actually be able to keep.
That’s why I’m looking past Realty Income at the moment. I think there are more attractive opportunities for UK investors to take a look at closer to home.
