Realty Income Corp (O) — Q4 2020 Earnings Call Transcript

Thank you all for joining us today for Realty Income's fourth quarter and year-end 2020 operating results conference call. Discussing our results will be Sumit Roy, President and Chief Executive Officer, and Christie Kelly, Executive Vice President, Chief Financial Officer. During this conference call, we will make certain statements that may be considered forward-looking statements under federal securities law. The company's actual future results may differ significantly from the matters discussed in these forward-looking statements. We will disclose in greater detail the factors that may cause such differences in the company's Form 10-K. I will now turn the call over to our CEO, Sumit Roy.

Thanks, Andrew. Welcome, everyone. As we remain in a remote work environment to promote the safety of our employees and community, I continue to be impressed by the resiliency and talent of our team to drive our business forward through the current pandemic. Additionally, I remain appreciative of the support and resilience of our clients and partners who continue to perform under challenging circumstances. On the personal front, we were excited to welcome Christie Kelly to our management team in January as Executive Vice President, Chief Financial Officer; and in February, Michele Bechor joined our team as Executive Vice President, Chief Legal Officer, General Counsel and Secretary. Mike Pfeiffer, who served as Executive Vice President, Chief Officer, General Counsel and Secretary, will retire after over 30 years of service. Mike will remain serving our company through June 2021 as Chief Administrative Officer and will continue leading our team members as well as assisting Christie and Michele through their transition at Realty Income until his well-deserved retirement. Words cannot fully reflect Mike's many contributions to our company for over three decades, and I'm immensely grateful for his partnership with me throughout the year. Moving on to financial matters, including a summary of the quarter and year. During the fourth quarter, we invested over $1 billion in high-quality real estate, including $467 million in the U.K., bringing us to over $2.3 billion invested during 2020, approximately $921 million of which was invested in the U.K. Investments during the year were largely concentrated in the grocery and home improvement industries, both of which continue to thrive during the current economic environment. We maintained low leverage and ample liquidity throughout the year while enhancing our financial flexibility. Highlights include the establishment of a $1 billion commercial paper program, our successful debut public issuance of sterling-denominated unsecured notes and record low coupon rates for 5-year and 12-year dollar-denominated bonds in the REIT sector. We have also been active in the equity capital markets to accretively fund our acquisition pipeline. During the fourth quarter of 2020, we raised approximately $605 million of equity, primarily through our ATM program. And in January, we raised an additional $670 million of equity through an overnight offering. Accordingly, our balance sheet is well positioned to address what continues to be an active investment pipeline. To that end, we are introducing 2021 acquisitions guidance of over $3.25 billion, as we are well positioned to continue the momentum we experienced at the close of last year and in January. In the fourth quarter of 2020, we invested approximately $1 billion in 70 properties located in 22 states and the U.K. at a weighted average initial cash cap rate of 5.4% with a weighted average lease term of 13.4 years. On a total revenue basis, approximately 68% of total acquisitions during the quarter were from investment-grade rated tenants. 71% of the revenue is generated from retail tenants. These assets are leased to 31 different tenants in 19 industries. Of the $1 billion invested during the quarter, $541 million was invested domestically in 59 properties at a weighted average initial cash cap rate of 5.2% and with a weighted average lease term of 15.1 years. During the quarter, $467 million was invested internationally in 11 properties located in the U.K. at a weighted average initial cash cap rate of 5.7% and with a weighted average lease term of 11.7 years. During 2020, we invested over $2.3 billion in 244 properties located in 30 states in the U.K. at a weighted average initial cash cap rate of 5.9% and with a weighted average lease term of 13.2 years. On a revenue basis, 61% of 2020 acquisitions are from investment-grade rated tenants. 87% of the revenues are generated from retail and 13% are from industrial assets. These assets are leased to 56 different tenants in 26 industries, two of the most significant industries represented are grocery and home improvement. Of the $2.3 billion invested during 2020, nearly $1.4 billion was invested domestically in 220 properties at a weighted average initial cash cap rate of 5.8% and with a weighted average lease term of 14.9 years. And approximately $921 million was invested internationally in 24 properties located in the U.K. at a weighted average initial cash cap rate of 6.1% and with a weighted average lease term of 10.8 years. Transaction flow remains healthy as we sourced approximately $17.1 billion in the fourth quarter. For the full year, we sourced approximately $63.6 billion in potential transaction opportunities. The most we have ever reviewed in a given year. Of these opportunities, $42.4 billion were domestic opportunities and $21.2 billion were international opportunities. Investment-grade opportunities represented 50% of the volumes sourced during the year. Of the $63.6 billion sourced, 56% were portfolios and 44%, approximately $28.2 billion were one-off assets. Of the $1 billion in total acquisitions closed in the fourth quarter, 66% were one-off transactions. Our investment spreads relative to our weighted average cost of capital were healthy during the quarter, averaging approximately 130 basis points. Moving to dispositions. During the quarter, we sold 60 properties for net proceeds of $77.5 million, realizing an unlevered IRR of 8.7%. This brings us to 125 properties sold during 2020 for $261 million at a net cash cap rate of 7.8%, and we realized an unlevered IRR of 11.6%. Our portfolio remains well diversified by clients, industry, geography and property type, which contributes to the stability of our cash flow. At year-end, our properties were leased to approximately 600 clients in 51 separate industries located in 49 states, Puerto Rico and the U.K. Approximately 84% of rental revenue is from our traditional retail properties. The largest component outside of retail is industrial properties at approximately 11% of rental revenue. Walgreens remains our largest tenant at 5.7% of rental revenue. Convenience stores remains our largest industry at 11.9% of rental revenue. Within our overall retail portfolio, approximately 95% of our rent comes from tenants with a service, nondiscretionary and/or low price point component to that business. We continue to believe these characteristics allow our tenants to operate in a variety of economic environments and to compete more effectively with e-commerce. These factors have been particularly relevant in today's retail climate, where the vast majority of recent U.S. retailer bankruptcies have been in industries that do not possess these characteristics. We remain constructive on the credit quality of the portfolio with over half of our annualized rental revenue generated from investment-grade rated tenants. Occupancy based on the number of properties was 97.9% at year-end. During the fourth quarter, we released 77 properties, recapturing 100.3% of the expiring rents. During 2020, we re-leased 314 properties, recapturing 100% of the expiring rent. Since our listing in 1994, we have re-leased or sold over 3,500 properties with leases expiring, recapturing over 100% of rent on those properties that were released. In light of COVID-19, rent collection across our portfolio has remained stable over recent months. During the fourth quarter, we collected 93.6% of contractual rent due and further improvement in rent collection percentages is primarily dependent upon improvements in the theater industry, which I will touch on shortly. We collected 100% of contractual rent for the fourth quarter from investment-grade rated tenants, which further validates the importance of our high-quality real estate portfolio, leased to large, well-capitalized clients. While we have not historically prioritized investment-grade rated tenants as a primary objective, during periods of economic uncertainty, high-grade credit tenants tend to provide more reliable streams of income, as the last several quarters have exemplified. Our top four industries, convenience stores, grocery stores, drug stores, and dollar stores, each sell essential goods and represent over 37% of rental revenue, and we have received nearly all of the contractual rent due to us from tenants in these industries since the pandemic began. Uncollected rent continues to be primarily in the theater industry, representing approximately 80% of uncollected rent in December. As the theater industry remains challenged, I would like to update the investment community on our latest view. The industry represents 5.6% of our contractual base. While we do expect the industry to downsize in the future, we continue to believe it will remain a viable industry in a post-pandemic environment, especially for high-budget blockbuster movies. You might recall that the U.S. box office reached an all-time high as recent as 2018, and 2019 produced the highest grossing worldwide film of all time in Avengers: Endgame. We continue to believe, particularly for blockbuster movies, that a theatrical release will be the preferred distribution channel for studios going forward, given the superior economics supported to them versus streaming platforms. That said, we do acknowledge that the industry is changing and that there likely will be a rationalization of theaters in a post-pandemic reality. Under this scenario, underperforming theaters may not survive. We continue to maintain a full reserve, the outstanding receivable balance for 37 of our 77 total theater assets and continue to recognize revenue on a cash basis for these 37 assets. During the fourth quarter, we established a full reserve for one additional theater asset, and we disposed of one theater asset previously on cash accounting. To be clear, we do not expect to lose the entirety of rent associated with these properties longer term, even in the event of potential closures. As of year-end, the total allowance for these 37 theaters totaled $23.7 million, including $1.8 million of which is a straight-line rent receivable reserve and thus has no AFFO impact. Moving on. Our same-store rental revenue decreased 3.2% during the quarter and 1.7% year-to-date. Our reported same-store growth includes deferred rent and unpaid rent that we have deemed to be collectible over the existing lease term, but it excludes rent where collectibility is deemed less than probable. The decrease in same-store rental revenue is primarily driven by reserves we recognized in the theater industry and to a lesser extent, the health and fitness industry. Now to provide additional detail on our financial results for the quarter, I would like to hand it off to Christie.

Thank you, Sumit, and I'm honored to have joined Realty Income as CFO. Having joined the Board in 2019, I have experienced firsthand the talent of our Realty Income team, together with the exciting growth opportunities for our business. I'm looking forward to working together with our teams to deliver our strategic objectives and realization of dreams and aspirations for all at Realty Income with Sumit and our Board of Directors. I also look forward to engaging with our investment community over time. We are grateful for the support of all of our loyal shareholders who have invested in Realty Income for over 26 years as a public company and for our future. I would now like to provide a general overview of our recent financial results, starting with the balance sheet. We have continued to maintain our conservative capital structure and remain one of only a handful of REITs with at least two A ratings. During the quarter, we completed our debut public offering of sterling-denominated senior unsecured notes, issuing GBP 400 million due 2030 for an effective annual yield to maturity of 1.71%. We also issued $725 million of senior unsecured notes in December through a dual tranche offering of 5-year and 12-year notes. Achieving record low U.S. dollar coupon rates in the REIT sector for each of those tenors. Additionally, we raised approximately $655 million of equity during the quarter, primarily through our ATM program. And in January 2021, we raised approximately $670 million through an overnight equity offering, which we earmarked to prefund an active investment pipeline to start the year. We ended the year with low leverage and strong coverage metrics with a net debt to adjusted EBITDA ratio of 5.3x or 5.2x on a pro forma basis, adjusting for the annualized impact of acquisitions and dispositions during the quarter. And our fixed charge coverage ratio remained strong at 5.1x. We ended the year with full availability under our $3 billion multicurrency revolving credit facility. No borrowings outstanding on our $1 billion commercial paper program and over $824 million of cash on hand. In January, we completed the early redemption of all $950 million, 3.25 notes due 2022, which was done to reduce our near-term refinancing risk and take advantage of attractive borrowing rates in the fixed income market. Looking forward, our overall debt maturity schedule remains in excellent shape with only $44 million of debt maturities through year-end 2021, excluding commercial paper borrowings. Now moving on to our income statement. AFFO per share during the quarter was $0.84 and $3.39 per the year on a fully diluted basis, representing annual growth of 2.1%. For 2020, our AFFO per share was negatively impacted by non-straight-line rent reserves of $44.1 million, which represents approximately $0.13 per share of dilution, over half of which is attributed to the theater industry. Now moving on to guidance. As we introduced our initial 2021 earnings estimate, we acknowledge that while some uncertainty related to the theater industry remains together with the backdrop of the pandemic, our confidence in providing guidance is supported by the overall health and stability of our portfolio combined with the acquisition pipeline. To that end, our 2021 AFFO per share guidance of $3.44 to $3.49 represents approximately 1.5% to 3% growth over 2020. Moving on to dividends. In December, we increased the dividend for the 109th time in our company's history. We have increased our dividend every year since the company's listing in 1994, growing the dividend at a compound average annual rate of approximately 4.4%. And we are proud to be one of only three REITs in the S&P 500 Dividend Aristocrat index for having increased our dividend every year for the last 25 consecutive years. And now I'd like to hand our call back over to Sumit.

Thank you, Christie. As we reflect on 2020, we stand behind the overall resiliency of our portfolio. The relentless efforts of our team to add shareholder value and the outlook for our business over the long term. The momentum in our investment pipeline and ample sources of liquidity, and our size and scale position us favorably to capitalize on near-term growth opportunities around the globe. At this time, I would like to open it up for questions. Operator?

Congratulations on the new role. To start off with the occupancy degradation you mentioned, could you discuss two things related to that? First, what are your plans to recover some of that occupancy loss? Second, as we look ahead to 2021, are there any other areas where we might see further occupancy declines?

Those are great questions, Vikram. Thank you. At the end of the third quarter, our occupancy was at 98.6%. When asked about our year-end expectations, we indicated it would be around 98%, and our actual figure of 97.9% was fairly close. We anticipated the NPC bankruptcy filing, with around 150 assets associated with NPC, predominantly Pizza Hut locations, and 19 Wendy's locations. We expected 66 of these assets to be rejected in the bankruptcy process, which influenced our guidance for approximately 98% occupancy. In the fourth quarter, we did receive those 66 assets back, which significantly contributed to the 97.9% occupancy rate. The net increase in vacant assets from the third to the fourth quarter was about 45. Despite regaining 66 assets, we managed to resolve more vacancies than we initially expected, as these locations are very well situated, allowing us to attract quick-service restaurants to take over some of these spaces. We are optimistic about quickly resolving these assets. It's important to note that many of the Pizza Huts operated by NPC had less than two years left on their leases. Our asset management team had already started exploring alternatives, anticipating that these assets would return, regardless of any bankruptcy filings. We are pleased with our ability to resolve these assets, and as shown by our results, we achieved the highest number of resolutions in the fourth quarter, marking a record for us. This reflects the excellent work done by our team, including Ben and TJ, who have excelled in this process even during the challenges of the pandemic. We are hopeful to exceed an occupancy rate of 98%. While we face some frictional vacancy, we've communicated that our goal is to maintain around a 98% occupancy rate, as we aim to reposition certain assets, which requires time. This will remain our target moving forward.

That makes sense. And then just one, Christie, for you. The overall AFFO growth, I know there's some dilution or maybe just some headwinds near term. You obviously prefunded some of this. Can you just give us a rough sense of the AFFO growth sort of in the first half year-over-year versus the second half of the year?

I think, Vikram, that in terms of where we're going to see AFFO growth, I think you can expect that to be a bit similar to historical norms outside of probably the second quarter of last year where we pulled back on acquisitions a bit. But nothing out of the ordinary.

Can you talk a bit about the decline in cash yields in the fourth quarter? Through the first three quarters of last year, the average cash yield was closer to 6%, and it declined to 5% in the fourth quarter. So could you just talk about what drove that decline? And you also mentioned that 61% of the 4Q volume was one-off transactions. So how should we think about the balance between one-offs and portfolios near term? And what type of pricing differential are you seeing there?

Yes. Good question, Haendel. As you pointed out, the lower cap rate was largely driven by the mix of assets that we purchased here in the U.S. If you look at the prepared remarks, I suggested that 29% of what we purchased here in the U.S. were industrial assets, single-tenant industrial assets. These were very well-placed assets with clients that are executing on their omnichannel strategy, had lease terms that were north of 10 years, some 15-year leases, good growth in markets that we wanted to enhance our exposure and with rents that were right around market rents. And so as you know, industrial assets tend to be trading a lot more aggressively. And as such, that certainly had a bit of a downdraft on our cap rate, but the fact that we were able to do 5.2% for the U.S. assets was largely driven by that.

Okay. I would like some details on the guidance for this year, which is at $3.25 billion. I'm interested in understanding the expected yields associated with that. Additionally, when engaging with potential sellers, I wonder if the potential repeal of 1031 exchanges might lead you to consider offering units to sellers, and how that idea might be viewed. Have you had discussions with potential sellers about this, and what initial feedback have you received?

Sure. Thank you for the questions, Haendel. We shared our first quarter pipeline in early January, indicating it was over $800 million, which reflected a robust pipeline stemming from a strong fourth quarter. Achieving $1 billion in the fourth quarter set a solid momentum for the first quarter, which has persisted. This demonstrates our effective sourcing and new strategies that have allowed us to achieve significant numbers compared to previous years. Regarding the expected cap rates, I think they will resemble those we achieved in 2020. The cap rates will depend on the types of assets closed in a quarter; for instance, industrial assets will likely have lower cap rates compared to retail ones, which might be slightly higher. Even in retail, especially essential categories, trading is happening in the mid-4s, indicating a more aggressive pricing environment. Fortunately, we maintain a favorable cost of capital and achieved a 160 basis points spread throughout the year, exceeding our historical average. This positions us well in terms of asset quality and portfolio reshaping. The cap rate will ultimately depend on the asset composition in any given quarter. Regarding the 1031 exchange impact and our ability to issue OP units, we've successfully done this before, allowing retail shareholders to convert proceeds into OP units. There is potential for this momentum to increase as sellers look to defer taxes. Nonetheless, 1031 exchanges play a minor role in our business, primarily involving vacant assets since most transactions we engage in pertain to existing tenants purchasing their properties. Though we may encounter some 1031 buyers during opportunistic sales, it's a modest segment of our interactions. On the acquisition front, if 1031 activity slows, especially for smaller properties like quick-service restaurants and drug stores, we might see a rise in cap rates, which could be advantageous for our single-asset acquisitions.

Welcome, Christie. I look forward to meeting you in person.

And Christie starting with you. First, welcome. Secondly, if you can just dig into guidance real quick. Is the acquisition guidance of at least $3.25 billion, which is an interesting way to say that you're probably confident you're going to get more than that. But how should we be thinking about what gets you to the top or bottom end of the AFFO per share guidance range, given that acquisition expectation?

I understand the question was directed to Christie, and I’ll let her chime in shortly. However, let me take a moment to address it. We aimed to present a range that accurately reflects the current circumstances, ensuring it was conservative enough so that if conditions do not improve, similar to what we experienced early this year and late last year, we would still be comfortable with this range. I believe there is significant potential for the outcome to exceed our projections, largely due to what happens in the theater industry as a whole, but also somewhat influenced by the health and fitness sector. We are optimistic that the theater business will recover, particularly as vaccination efforts progress, with daily updates on Pfizer, Moderna, and potential approval for Johnson & Johnson showcasing a path to herd immunity. Some models even suggest we could approach herd immunity by the end of June. Additionally, I’d like to highlight the success observed in China during the Lunar New Year, where they recorded exceptional ticket sales—one film surpassed the revenue record set by Avengers: Endgame in the U.S. and Canada. All these factors lead us to believe that upside potential exists beyond what we've outlined in our model, which could help us reach the higher end of our range. If various conditions align favorably, we might even exceed expectations, although we cannot assume that will happen. When evaluating different outcomes, we arrive at a probability-weighted result that we have communicated to the market. The theater industry's recovery will significantly impact this, and our past discussions have explained our assumptions regarding 37 of our 77 assets and their cash accounting implications on our base model. If you perceive our estimates as overly conservative, there is indeed room for upside, which excites us. Additionally, as you noted, we are also enthusiastic about opportunities in the acquisition market.

Thank you, Sumit. And Greg, thanks so much for the question. But I absolutely echo everything that Sumit has said. We spent, as you can imagine in the backdrop of 2020, a good bit of time really thinking about the guidance and being very thoughtful about how we went out in terms of our range of AFFO per share. And as Sumit said, there are a number of levers that we have to the upside in terms of sale-leaseback transactions, a bit more on the acquisition side and also really looking at primarily the theater industry. And so there is positive momentum. And in light of that, we do feel, as Sumit said, very good about where we are right now and the momentum that we have in the business.

Sure. I would estimate that around 20% of our leases have CPI adjustments, possibly a bit more. Many of these leases come with floors and ceilings. In a rising CPI environment, we have some level of protection, although there are typically set limits on adjustments, particularly in the U.S. We've faced inflationary challenges before. With our net lease nature, we're less impacted by rising inflation because our tenants cover costs like insurance and property taxes. Given that, we feel positive about our situation. Recently, we've seen a rise in the 10-year treasury in anticipation of inflation, but our spreads have also decreased, and while our all-in cost has risen slightly, it hasn't been significant. Currently, we can issue 10-year financing around the 2.12 to 2.22 range, which is still favorable compared to our historical rates. Our financing costs in the U.K. and Europe remain attractive due to low interest rates and contained inflation expectations. Our diverse financing options help mitigate risks from inflation expectations in different regions, and having long-term leases is an additional advantage. If inflation expectations lead to improved GDP growth, it could enhance our tenants' fundamentals. This year, only about 1.7% of our leases are expiring, but in the coming years, we expect to see higher market rents during lease renewals, particularly in 2022 and 2023 when more leases will expire. There is a concern that if interest rates continue to rise, it will affect our cost of capital, which is true. However, historically, cap rates tend to follow interest rates, albeit with a lag, allowing us to maintain our spreads and potentially improve them if cap rates rise faster than our capital costs. We believe we are well positioned as a company, and based on our recent investments and focus areas, we're confident in handling a rising interest rate and inflation expectation environment.

Welcome to the earnings call. Following up on the guidance question, one of the points you mentioned was about income taxes and their expected increase in 2021, which I believe is related to U.K. activity. Could you provide more details on the factors driving this increase and how we should consider it moving forward? Is this primarily a result of U.K. activity?

It is, Caitlin. And I think that you can expect modest increases as we continue to expand our U.K. presence.

Okay. So if we look at like the year-over-year increase from 2020, I guess, should we just see that if you're making a similar amount of U.K. investment dollars that the income tax dollars may go up at, I don't know, kind of similar type rate?

Similarly, yes.

Okay. And then when we think about the deferrals that Realty Income put in place in 2020, I guess, could you give some detail on when you expect to receive those and to the extent that any have already been built, kind of how that collection is going? And similarly, when you'll start to know if the reserves you were taking were conservative, right? Or sort of the opposite of conservative would be aggressive.

Sounds good, Caitlin. I think, first of all, what I can say is that as it relates to the deferrals that we've been taking. Essentially, when we look at the overall deferrals, we're really looking at a short-term payback and within 18 months. And as it relates to collections and the like, we are experiencing collections even before the deferrals are coming due. So we've been having some positive traction on that. All that being said, we've got 2021 in front of us.

Got it. Okay. So when we think about what's built into guidance and the reserves that you guys took last year, obviously, you gave the guidance range. You gave thinking that it would be accurate, but is it right to think that as we go through 2021, we'll start to maybe even early in the year, get some clarity on whether or not the reserves you took in 2020 were the right amount?

Yes, yes. And we go through, Caitlin, you may already know this, but a very rigorous review on our receivables positioning and it's cross-functional. It involves finance, it involves legal, our asset management group and research. And so in terms of the actions that we've taken, we feel very solid about the reserve position. And as we look forward, our collections have been consistent and steady. Where we are right now in the fourth quarter, we've got close to 94% of collections. And really, when you take a look at the uncollected rent in our company, it's really a story about theaters. 80% of the uncollected rent is focused on the theater business, which is 5.6%, as you know, of our contractual rent base. And the remaining of the story is really around health and fitness, which is primarily the remaining 16% of uncollected rent. And we did incur some collections on the health and fitness business. As Sumit said and we've talked about, we still have theaters in front of us. But there've been really positive momentum, and we view that potentially could be an upside for our business going forward.

Just a question regarding your comments on the movie theater business. Considering this, would you consider increasing your investment in movie theaters on any scale in the future?

Yes. So Rob, I think this question was asked last quarter as well. Look, we like to reach other business. But one of the lessons learned through this process is that should this represent at least when the pandemic started 6% of our overall portfolio. And I think what we have concluded through this process is that this business should survive, but there will be some level of real estate rationalization. And we are very happy to have put together this portfolio largely through sale leasebacks with the operators themselves. And so feel very good about our current portfolio. But the idea long-term is to continue to dwindle our exposure to this particular industry to something that is closer to a 3% ZIP code. So I think that answers your question, Rob. We feel like, over time, we need to get it down to about 3% of our overall portfolio.

Okay. Helpful. And then how are you thinking about non-U.K. European acquisitions at this point and given what's going on over there?

Non-European U.K. acquisition? So how am I thinking about the U.K. acquisition?

So regarding non-U.K. European acquisitions, specifically in Germany and Scandinavia, do you see the U.K. as a starting point for making larger acquisitions and expanding throughout Europe? Will the focus remain solely on the U.K. in the near term? How do you view this in light of your experiences over the past 12 to 18 months? Should we anticipate more acquisitions in 2021 or early 2022 beyond just the U.S. and the U.K., specifically in continental Europe?

We've always said that the U.K. was our first step into a European strategy, a western European strategy, and that continues to be the path that we are embarking upon, Rob. We are very well-established in the U.K., some of the numbers that we have posted, I believe, is a testament to that statement. I'm delighted to also share with you that we've hired another full-time person at Negara in our U.K. office. Who has a lot of experience doing acquisitions and has a lot of relationships, et cetera, in the Western European markets. And so the goal is to continue to look for transactions and not be constrained by geography, but look for the right transactions. And there are markets that we have identified in Western Europe that we would like to be able to grow into. But it's largely a function of do we have the right operators willing to transact at the right prices, et cetera, et cetera. So are we open to acquiring in Western Europe? The answer is categorical yes. But do I expect to see something happen in Spain? I don't have a timeline for that or something in France or Italy or Germany, I don't have a timeline for you. It's largely going to be a function, what's available and who we can get to work with and whether they fit into our overall target client list.

And the financing options in the continent over there, are they as attractive to you at this point as the U.K.? If you were to buy something, would you finance it in local currency?

Absolutely. I mean, that's been our goal is to try to minimize our exchange rate risk as much as we can, and we would follow a similar pattern to what we did in the U.K. where we did our debut, Sterling offering and prior to that, we had done a private placement, raising capital in U.K. denominated pounds. And that will continue to be how we finance our transactions. And that's where it becomes super exciting, Rob. I mean, you can do a 10-year paper in euro-denominated debt at 65, 70 basis points. Yes, cap rates are a lot more aggressive. But when you sort of factor in the cost of financing for somebody who's A-, A3 rated, it suddenly starts to make a lot of sense. And I think continuing to create alternative sources of capital, continuing to look at additional paths to growing our business is something that our platform allows us to do. And it's one that we are excited about, and we'll continue to push on.

Most of my questions have been addressed, but I have one more. Your grocery sector exposure has significantly increased in recent years, and I understand this was a strategic decision. It's now close to 10% of your rents. Could you share your long-term perspective on this sector, especially considering the rise in online grocery delivery during the pandemic? Currently, it seems that online orders mostly come from local stores, but do you foresee any risks if this starts to disconnect from customers' local stores? Could this make grocery stores face more challenges from an e-commerce standpoint?

Yes, Brent. If you visit a local grocery store, you'll notice they are still quite stocked, which is noteworthy as they are considered essential retail and continue to perform well. Our main focus is on partnering with operators that have an omnichannel strategy. For instance, the U.K. grocers we work with lead in the click and collect and delivery markets. Most of our partners have or are developing a strong omnichannel presence, supported by their robust balance sheets. This seems to be the future of the industry, and we are confident in the operators we have chosen to work with; they are positioned not just to survive but to thrive with the increasing demand for delivery and click and collect services. Regarding our exposure in this industry, I can clarify that while it is approaching 10%, we are not reaching any limits. Our investment policy permits us to go up to 15%, and we can request exceptions from the Board if necessary, providing a solid rationale for why such a move would be beneficial. We are very comfortable with this industry, Brent.

Okay. Yes, that makes sense. I was just curious what your longer-term thoughts were. And then just 1 other quick one. I don't know if you've really got much to say about it. But the power grid issues in Texas recently, you have decent exposure to that market. Anything we should expect there longer term? Or is it just a blip?

I don't want to downplay what's happening in Texas. However, our exposure there is manageable because our triple net business model allows operators to handle most situations. Fortunately, the disruptions were mostly temporary, so most businesses should be able to recover. There may be some issues with product availability during this time, but I don't anticipate this being a significant problem for our clients in Texas.

Just looking to total commitments for your development pipeline. I realize it's a small portion of your overall capital deployment, but it is fairly elevated versus historical norms. So I was just wondering if you could provide some color on how you're thinking about this bucket? Should we expect it to remain elevated? And what kind of stabilized yields are you underwriting?

Yes. Spenser, that's a great question. There's a reason why we have that sheet in our supplemental, and we want to lay it out as clearly as possible. This is another one of the avenues us to continue to gain exposure to certain clients and do it at a cap rate that is north of what you would be able to transact in the open market. And so it is about $160 million of commitment, $100 million of which is not funded yet. But if you look at the breakup, you will see that it's largely driven by two forward commitments we have on the non-retail side of the business. And so what that allows us to do is, again, enter into these contracts in a particular asset type that is trading super aggressively and be able to transact and get assets maybe 40, 50, 60 basis points north of where these assets would be trading had they been available today. And so I think that is part of the advantage of doing this. And this is, again, using our credit, using our scale and size to be able to get some of these assets at higher cap rates than what we would on the open market. The other side of this is repositioning. I think it was Vikram, who had asked about, hey, how are you thinking about these assets from NPC. We have a history of being able to reposition some of our assets and be able to really capture and enhance our rent from the same exact location by simply repositioning these assets. And that is something we've been doing for a few years. They tend to be smaller dollar amounts. But once again, we've given you that detail in the supplemental. And that will continue to be a bigger and bigger portion of our business. And I think as you've seen, the velocity of our lease terminations, et cetera, will only increase. And this part of our business, which we have seasoned over many years, will start to play a bigger, bigger role and will certainly, we hope, be a value-enhancing part of our business model. And so I would love to see this business continue to increase within the parameters of what I just shared with you and help us create another source of value creation for the overall business.

Just got a quick question on dispositions. How is demand for the noncore assets for the tenants that are impacted by COVID? I know you were able to sell a theater this quarter. Do you know if that will stay a theater?

Not sure. But I think, Wes, we've talked about this again, some of these theaters are located in prime locations. And we've already shared with you that, look, we don't think that the footprint of the theater business, pre-pandemic is going to be exactly the same post pandemic. So there will be some level of rationalization. But the good news is there is a fair amount of demand for last-mile distribution, and there's much more of a focus on the development of multifamily, given some of the trends that we are seeing in some of these markets. So it is quite possible that these assets, given that they sit on potentially 10, 12, even 15 acres of land, could be repositioned to a higher and better use. But that question, Wes, I think, is going to be very specific to the particular location and where that particular theta falls in the performance rankings. And if it tends to be in the top 2 quartile, I would say that, yes, the likelihood of it remaining at theater is high. But if not, I could easily see it being repositioned. Perhaps not easily but certainly repositioned.

Okay. Could you share how much of the ABR is from tenants on cash accounting and what percentage is collected from that tenant base? Are most of those related to tenants that are currently in bankruptcy?

Christie, do you want to take this one?

When we look at our overall collections, I previously mentioned that they are stable at 94%. About 80% of the collected rent comes from the theater industry, while the remaining portion is related to health and fitness.

Sumit, sorry if you already covered this. But I heard you quote cap rates on a few levels. But when we look at your $3 billion-plus acquisitions, we would assume some good-sized portfolios incorporated in that. Can you speak to portfolio premiums right now versus one-off deals? And maybe if you can bifurcate if there are premiums between retail and industrial?

That's a great question, Todd. Even as recently as last year, we noticed a portfolio discount rather than a premium. However, we've seen some portfolios enter the market at higher prices. I'm uncertain about where this trend is headed. As I mentioned earlier, certain industries and tenants that we looked at before the pandemic are now trading about 40 to 50 basis points lower as a portfolio. It’s challenging to make a broad statement applicable to all industries and operators. Generally, in most areas, particularly the higher-yielding sectors, portfolio transactions tend to reflect a discount rather than a premium. Yet, in certain favored industries, we are observing some tightening. Regarding the $3.25 billion, we are not basing our predictions on large portfolio transactions, so anything of that nature would exceed our current projections. This could also represent a potential tailwind for our business. There are several public sale-leaseback transactions available, none of which are included in our reported figures. Cap rates have indeed compressed, even over the past four to five months. For retail and industrial here in the U.K., the rates are relatively steady, though still aggressive. Overall, the market has become pricier compared to six months ago. Fortunately, the cap rate market in the U.K. is more stable, though I wouldn't say it’s compressing. Interestingly, we often find ourselves as the only party in certain transactions, only to have one or two other buyers appear in later deals. It’s a unique acquisitions environment at the moment. We remain optimistic; our advantages position us well to secure a larger share of transactions, which will help drive our earnings growth.

Wes, I wanted to circle back on your question. Because I had the theater numbers in my mind. But you were asking about cash accounting. And I just wanted to let you know that right now, we have almost 50 clients on a cash basis. And just to give you some color, it's a little over $5.5 million of monthly rent exposure, for which over half of that is associated with the theater industry. Let me know if that helps.

Okay. Todd, any other questions?

That's it for me.

First off, welcome to the earnings call, Christie. Thank you. I know we're getting a little long on the call here, so I'll keep it to 1 question. Has there been any change with regards to rent collection quarter-to-date in 1Q '21 versus, say, 4Q '20? I mean essentially, can you provide any color on any of these troubled industries or non-paying tenants? Are any of them starting to maybe pay that hadn't been paying in December, November, October?

Yes. I could probably help with that a little bit. I mean, if we take a look at year-to-date, the January recollection was relatively consistent with what we've been seeing in the past months towards that 94% range. And essentially, the theater industry is still the majority at approximately 80%. And we did see some pickup as it relates to health and fitness. And it's a little early for February. But overall, as we said at the start of the call, it's consistent and steady.

Okay. But the improvement you've seen so far this quarter has been largely on the health and fitness side rather than the theaters?

Like that, yes. But I would like to say too that theaters are paying.

It's Michael Bilerman. Can you hear me?

Yes. We can hear you, Mike. This is what happens when I'm in the office. Katie is in Philadelphia. We have an associated home. Creates that lot merging that doesn't work too well sometimes. I was wondering if you can provide some perspective. Obviously, when you switch over from banking, you went to Duke as the CFO. And then with CBRE, you sit on Park Hotels, Kite Realty, Tiers Board. You came out to Realty Income board last year. Net lease and what Realty Income is very different from those other companies in terms of the type of business in terms of creating growth with this longer duration net leases really where the competitive advantage is the cost of capital. And obviously, the relationships that the company has. But the secret to this company is being able to access well-priced capital and finding the deals. Just talk about sort of your perspectives and how you think the company should be capitalized? How you think about capital raising relative to your prior experiences?

Certainly, Michael. It's great. Great to hear your voice again, and I look forward to seeing you in person. But I wasn't at CBRE. I was at JLL. In terms of my overall thoughts, Michael, we've known each other for a long time, and you clearly understand the triple-net lease business. Being competitive and effectively utilizing our scale and insight on the capital markets is something that has been evident from us historically, at the start of the year, and will continue as we move forward. As Sumit pointed out, we are optimistic about the activity we see in the U.K. debt markets and our ability to execute there. We also believe there are some very favorable conditions on the continent from a debt perspective. Regarding our capitalization, you can expect us to maintain our balance sheet and focus on achieving a net debt-to-EBITDA ratio of 5.5x, as indicated. As for the other businesses, Realty Income is an outstanding operation with a strong team, and I am thrilled to become part of it. We have significant growth opportunities ahead and, as Sumit has mentioned, some exciting initiatives to enhance value for our clients.

Just wanted to see what the latest was on the 7-Eleven portfolio that's in the market and kind of your current feeling about if you would consider adding to your 7-Eleven exposure?

Joshua, I'll take that question. So we don't talk about specific transactions. You also can see that 7-Eleven is a top 10 tenant of ours. It's a client that we have done repeat business with. We help do their first sale-leaseback in 2016 and did subsequently four other sale leasebacks directly with them. So clearly, it's an operator that we really like. It's in an industry that we like, and especially the standing that 7-Eleven has within the convenience store business, we really like their positioning. And so then the question becomes okay, what about the 11% industry exposures that you have to convenience store business. Is that a factor that could potentially curb our ability to do more? And I think I've answered this question before, we have a limit of 15%, and we can always get exceptions in the event we can make the case that a particular industry is one that we are very favorable, we implying towards and would like to see it increase. And this is one of those industries that we would feel very comfortable in increasing our allocation to. But again, we have to be very specific that it's industry increase in allocation, but with particular clients in mind and 7-Eleven would that will be falling in that bucket.

In terms of acquisitions, what type of competition do you run into on larger portfolio deals? And who would be willing to take on tenant concentration to get some of these larger deals done?

Are you asking us about whether we would be willing to take the tenant concentration? Or is this a general question, Linda?

It's just more of a general question around competition. When you're looking at these larger portfolio deals, and maybe who some of the competitors are out there that would be willing to take on concentration?

Certainly. One key point we discussed is that our size and scale allow us to handle large portfolios, which I define as those exceeding $1 billion. Most of our competitors would face concentration issues with portfolios even half that size, particularly if they already have existing exposure to a particular client. We are fortunate to be in a position where we can increase our allocation to a client, thanks to the strength of our overall business and balance sheet. However, transactions of $5 billion or $6 billion are rare, and I doubt there are any other public net lease buyers able to consider such large deals. The alternative buyers are primarily influenced by the financing landscape, with asset-backed securities becoming a favored way to finance these large transactions, especially with highly rated operators. Once that is established, private equity firms tend to get involved and are eager to invest at that scale, leveraging the portfolio up to about 85% or 90% to enhance their cash-on-cash yield. This group represents traditional competition for large sale-leaseback opportunities with strong operators. However, with rising interest rates, some of these buyers may feel pressure, as the cost of financing at that level starts to increase. Ultimately, our competitive landscape will be shaped by the conditions in the financing market.

Got it. And then just in terms of the cash basis tenants, what percentage did you collect from the cash basis tenants in 4Q and in 3Q?

Yes. I'll let Christie answer that.

We had a couple of million. Linda, I believe. Okay.

And then just for the 40 theaters that aren't on a cash basis, it sounds like we should assume they're paying some level of rent. For the 40, are they concentrated under one banner versus another? In your disclosure, you show 40 Regal and 32 AMC?

Yes. I can answer that. Yes, about 41 of these assets, when we did our internal analysis, we deemed them to be in this top quartile. And that's how we came up with the 41. But when we talked about us getting some rent from both AMC as well as Regal, especially in the month of December, it was across the entire portfolio. So even those assets, those 37 assets that we have on cash accounting, they paid us rent. Not 100%. But they paid us some rent for the month of December, and that's really the upside for us going forward.

Thank you, everyone, for joining us today, and we look forward to speaking with you at the upcoming virtual conferences. Take care. Bye-bye.

Thanks, everybody.