Realty Income Corp (O) — Q3 2021 Earnings Call Transcript

Thank you all for joining us today for Realty Income, Third Quarter 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, and Treasurer. 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 any forward-looking statements. We will disclose in greater detail the factors that may cause such differences in the Company's Form 10-Q. We will be observing a 2-question limit during the Q&A portion of the call in order to give everyone the opportunity to participate. If you would like to ask additional questions, you may re-enter the queue. I will now turn the call over to our CEO, Sumit Roy.

Thanks, Julie. Welcome, everyone. Our strong relationships with all our stakeholders enabled the success of our business, and we thank everyone listening for your continued support. Additionally, I would like to express my appreciation of our expanded Realty Income team for their tireless efforts in executing our strategic objectives. Today, our business is at an inflection point, where the advantages of our growing size and scale provide us with an accelerating number of opportunities, compounding our aptitude for growth. We see momentum accelerating across all facets of our business as a result of the following growth catalysts: 1. The depth and breadth of our active global pipeline remains robust. During the third quarter, we acquired over $1.6 billion of real estate across three countries, resulting in approximately $3.8 billion year-to-date. We now expect to invest in over $5 billion of real estate in 2021, an increase from our prior guidance of $4.5 billion. 2. We believe our expansion into Continental Europe during the third quarter will significantly deepen our addressable market at attractive spreads relative to our weighted average cost of capital, particularly given the comparatively low unsecured borrowing rates in the European bond market. 3. Our asset management activities continue to generate strong results; at the end of the third quarter, our portfolio was 98.8% occupied, and we achieved a rent recapture rate of 107.2%, illustrating the relentless efforts of our asset management team and highlighting the quality of our real estate. 4. Finally, with the closing of the VEREIT merger, we believe our size, scale, and diversification will further enhance many of our competitive advantages, allowing us to augment our investment activities in the future. With the closing of the merger with VEREIT expected on November 12, we can provide enhanced clarity on our near-term earnings run rate. To that end, we are increasing our 2021 AFFO per share guidance to $3.55 to $3.60, representing 5.5% annual growth at the midpoint, and we are introducing 2022 AFFO per share guidance of $3.84 to $3.97, representing 9.2% annual growth at the midpoint. Our 2022 guidance assumes over $5 billion of acquisitions and over $40 million of year-one G&A synergies we have identified as a result of economies of scale from the merger. These guidance ranges also assume that the anticipated spin-off of our office properties is consummated as anticipated on November 12. With the closing of the merger, our combined company eclipses $50 billion in enterprise value, with the size and scale to support new risk growth verticals, providing flexibility to close large transactions without creating concentration risk. Furthermore, through this merger, Realty Income has inherited a platform and a talented acquisition team focused on sourcing higher-yielding products that will be additive to our existing pipeline. Over time, we expect to generate meaningful earnings accretion by refinancing our outstanding debt supported by our comparatively lower borrowing costs driven by our A3 and A- ratings and capacity to issue debt in lower yielding markets. Finally, we are excited to integrate the capabilities of many talented VEREIT colleagues into the Realty Income business as we continue to execute our growth initiatives as one team. Now turning to the results of the quarter, we continue to add attractive real estate to our portfolio at a rapid pace. During the third quarter, we sourced nearly $24 billion of acquisition opportunities, ultimately selecting and closing on less than 6%. Of the $1.6 billion of real estate we added to the portfolio in Q3, the largest industry represented was UK grocery stores. On a revenue basis, approximately 38% of the acquisitions made during the quarter were leased to investment-grade rated clients, and our total investment-grade client exposure remains approximately 50%. The weighted average remaining lease term of the assets added to our portfolio during the quarter was 13.4 years. In aggregate, all of our acquisition activities during the quarter resulted in healthy investment spreads, up approximately 164 basis points. As of quarter-end, our portfolio remains well diversified, including over 7,000 assets leased to approximately 650 clients who operate in 60 separate industries located in all 50 U.S. states, Puerto Rico, the UK, and Spain. Giving pro forma effect to the closing of the merger and the anticipated spin-off of our combined office assets as of September 30, 2021, our portfolio now includes over 10,500 assets located in all 50 U.S. states, Puerto Rico, the UK, and Spain. Our international pipeline continues to add meaningful value to our portfolio, and we believe it will remain an important driver of growth going forward. Of the nearly $24 billion in acquisition opportunities that we sourced this quarter, approximately 34% was associated with international opportunities. In the third quarter, we added approximately $532 million of high-quality real estate in the UK and Spain across 31 properties, bringing our total international portfolio to over $3.2 billion. This quarter, our international acquisition accounted for approximately 33% of total acquisition volume. As previously announced in September, we made our debut acquisitions in Continental Europe through a sale-leaseback transaction with Carrefour in Spain. Subsequent to quarter-end, we announced the completion of an additional Carrefour transaction in Spain, bringing the value of our Continental Europe portfolio to approximately €160 million. We are optimistic about our momentum in Spain as we look to replicate the success of our international growth platform throughout the continent with best-in-class operators who are leaders in their respective industries. The health of our core portfolio remains of utmost importance as we continue to expand our platform. At the end of the third quarter, occupancy was 98.8% based on property count, which represents an increase of 30 basis points as compared to the last quarter. During the quarter, we released 50 units, recapturing 107.2% of expiring rent, bringing our year-to-date recapture rate to 105.5%. We continue to report on quarterly recapture rates and believe this is one of the most objective ways to measure underlying portfolio quality in the net lease industry. Since our listing in 1994, we have executed over 3,800 releases or sales on expiring leases, recapturing over 100% of rent on those released contracts. At this time, I'll pass it over to Christie, who will further discuss results from the quarter.

Thank you, Sumit. This quarter, our business generated AFFO per share of $0.91, strengthened by our acquisitions pace and the collection of almost 100% of contractual rent in the third quarter. During the quarter, our theater clients paid approximately 99.6% of contractual rent, representing a meaningful improvement compared to the 38% collection rate in the second quarter. We continue to be encouraged by the strong box office performance of recent blockbuster releases, which we believe signals the long-term viability of the theater industry. I was looking forward to the release of the James Bond film 'No Time to Die' for months, and based on recent box office numbers, there were many across the globe. We currently have 34 of our 79 theater assets on cash accounts, with approximately $37 million of non-straight-line reserves on our balance sheet. Like our business strategy, our approach to evaluate when these 34 theater assets move back to an accrual basis and the appropriate time to reverse the allowance for bad debt reserves will be conservative and data-driven. More specifically, we will assess the likelihood of collecting on this amount by evaluating store level and industry-wide data in conjunction with continuing payments of past due rent over a healthy period of time. As we continue to expand our platform, we will remain steadfast in prioritizing low leverage and a conservative balance sheet strategy while financing our growth initiatives with attractively priced capital. At the quarter-end, our net debt-to-adjusted EBITDA ratio was 5 times, or 4.9 times on a pro forma basis adjusting for the annualized impact of acquisitions and dispositions during the quarter. Our fixed charge coverage ratio hit an all-time high for the third quarter in a row, coming in at 6.1 times. During the quarter, we raised over $1.6 billion in equity, approximately $594 million of which was through an overnight offering that closed in July, and the remainder primarily through our ATM program. During the quarter, we also issued our debut green bond offering at $750 million multi-tranche sterling-denominated unsecured bond offerings, which priced at a blended yield of approximately 1.48% for an 8.8-year blended tenant. We look forward to continuing to partner with our clients around sustainable practices in accordance with our Green Financing Framework.

Thank you, Christie. In summary, we are energized and pleased by the momentum we see across all areas of our business. We're proud to have closed the merger with VEREIT, and we expect the benefits of this transaction to be broad and lasting, enhancing our competitive advantages and generating shareholder value for years to come. Going forward, the possibilities of our business will be constrained only by our imagination. We look forward to continuing to execute our strategic growth initiatives to strengthen our position as the global consolidator of the highly fragmented net lease space while providing our shareholders with compelling risk-adjusted returns over the long run. At this time, I would like to open it up for any questions.

Thanks for taking my question, and congrats on the merger.

Thanks, Nate.

Yes. I appreciate the color on the pipeline. I would just maybe you could give a little bit more detail just heading into the end of the year and into next year. What is the mix look like in terms of industrial versus retail U.S versus Europe? Was there a lot of overlap in the pipeline between VEREIT or the merger? Then I'll ask my second question at the same time. Just if you can comment on pricing dynamics U.S. versus Europe.

Thank you, Nate. Good questions, and yes, we're so happy to have the merger behind us. In terms of the composition of the pipeline ahead, as well as what we've achieved, we have shared with the market that they should expect international acquisition to represent about one-third of our acquisition volume going forward. In terms of pricing, surprisingly, when I looked at the spreads that we're generating, either here in the U.S. compared to what we were able to do in Europe, they are very similar for this quarter. In some quarters, we've seen that we were able to get slightly higher yields in the international markets and in other quarters, it has been the opposite. So there’s really no defining narrative there. The way we are thinking about our portfolio is through a macro lens that we have identified what it is that is of interest to us. The area that we play in Europe is slightly narrower, and it's a function of the product that's available compared to what we play in the U.S. In terms of retail versus industrial, as much as we would like to do more industrial, the pricing in this market keeps us fairly constrained to that 10%. On a good quarter we are able to get to that 15%-17% range. But that's the composition of the industrial makeup of the overall acquisition. The rest of it is primarily retail. In terms of investment grade versus non-investment grade, we've said this in the past and I'll repeat it again. When we look at credit and we conduct our analysis, we don't disqualify non-investment grade credits immediately. If you look at what we were able to achieve in the third quarter, only 38% of what we did was investment-grade. So, we are comfortable looking at non-investment grade. A non-investment grade does not necessarily mean sub-investment grade. It just means that it doesn't have a rating from one of the two major rating agencies, and it might actually have a sub-investment grade rating, but we're very comfortable with that. Regarding your question on overlap with what we are inheriting from VEREIT, there really isn't much. There are certainly certain acquisition opportunities that we would find as competitors, but they play in an area that we believe can truly be additive to our overall platform. We are really excited to inherit this team and are looking forward to completely integrating them into our acquisitions team and having them continue to pursue the transactions while potentially not being constrained by the cost of capital. So, we genuinely believe that this is going to be incremental to the acquisitions that we were able to achieve independently. With respect to pricing, I think I addressed that through my spread comments. So, Nate, I don't know if there's anything specific you want me to dive into.

No, that's all very helpful. Thank you. I'll get back in the queue.

Thanks.

Thanks, Sumit. Hi, Christie. Thinking about the merger with VEREIT, where they have fewer true triple-net leases on average than you do. What percent of leases after the acquisition and spin-off are truly triple-net or will truly be triple-net? Will we be looking to offload some of those non-triple-net leases? In general, how should we be thinking about the level of dispositions versus the $5 billion or more of acquisitions in 2022?

Good questions, Greg. I believe the only area where I felt we probably had non-triple net leases was on the GSA side of the equation on the office sub-portfolio that VEREIT had exposure to. Otherwise, largely, Greg, they had triple-net leases. If you think about how this particular portfolio was put together, we will be able to give you a lot more color once we've got it all integrated, but I'd be very surprised to find a preponderance of gross leases on the retail and industrial side. Obviously, industrial products typically require the landlord to be responsible for things like roofs and structure, which one could argue is not a pure triple-net lease, but that is largely the same case with respect to our portfolio as well. The property maintenance along with property taxes and insurance are still the responsibility of the tenants. So, we view those as predominantly net leases. With the spin-off of the office assets, I think we will largely be a net-lease portfolio, very similar to what we have. I don't think that’s going to pose any major issues, Greg.

Okay. I was just looking at their various disclosures, and it has a net around 30% on the retail side, 40-something percent on the industrial side, which are double net, but I get your point on the level of obligation that’s really entailed. In terms of the level of disposition we should be thinking about, whether there's any cleanup there, or just in general versus the $5 billion of acquisitions?

Yeah, we've been doing about a $100 million to $150 million in dispositions. We've gone past $200 million in dispositions on a standalone basis. We would like to inherit and really do a similar analysis on the portfolio that we are inheriting from VEREIT to see if that needs to be altered. A lot of the capital recycling that they were doing pre-merger was on the office side of the equation. I don’t know if the number will dramatically increase beyond a linear extrapolation of going—adding another $10 billion to $14 billion of assets. So maybe the $150 million becomes $250 million or $275 million. But give us a quarter to digest this and filter it through our asset management lens, and we'll be able to come back to you with a lot more precise indication. We don't suspect that it's going to be dramatically different from the run rate that we were doing on a standalone basis.

Okay. And then just one quick point of clarification on the $24 billion opportunities, you said 34% was international; is that all of Europe or just the UK and Spain for now?

Primarily the UK and Spain, but we are certainly looking at other geographies that we have identified as core to our expansion objectives. But it is primarily in the UK and Spain.

So we could see that source number go up as you start looking more intent?

As we start expanding, yes, you should expect that to go up.

Okay. Thank you.

Sure.

Thanks, everyone. Hey, how are you? On the acquisition guidance for 2022, you've talked about how the VEREIT team will be additive, but then the guidance remains the same, over $5 billion for 2022. Is that just beginning of the year conservatism because there's limited visibility in the pipeline, or how should we think about that?

Look, what did we start this year with? It was right around $3.25 billion. Then we went up to $4.5 billion, and now we're about $5 billion. We want to provide numbers that we have a very high level of certainty associated with. As we start to develop our pipeline and visibility, we expect that number to go up. But we don't want to come out with a number that we feel is overly aggressive coming out of the gate. This has been very important to us to deliver to the market what we say we will deliver. You should consider this to be our initial guidance, and the hope is we can do better than that. As soon as we are into next year, we hope to be able to get more precise regarding what the acquisition guidance ultimately turns out to be.

Okay. Next one, maybe for you, Christie. Also, on the '22 guidance, is there anything in there that would be considered kind of one-time in nature, like maybe a reserve release from the theaters or anything like that? We need to consider?

Hi, Brad. There is nothing of a one-time nature, including reversals at the theater returns.

Okay. Thank you.

You bet.

Hello out there.

Hi Haendel.

Hi Haendel.

So, I was intrigued by your comments. You mentioned inheriting a team that experienced acquiring high-yielding assets that will be added to your platform, and then you also mentioned being very comfortable acquiring higher yield. I was going to ask if this quarter's 38% investment-grade volume was an anomaly, but it doesn't sound like it is. So maybe, can you talk us through your thoughts on portfolio strategy concerning high-grade going forward and if you are signaling perhaps a slight shift in your overall thinking of portfolio strategy?

I'm here to alleviate any confusion, Haendel. If you look at our top 10 clients, Carrefour shows up there, and Carrefour is a non-rated company. Yet, if you were to look at its balance sheet and credit metrics, it would imply a very strong investment-grade credit, but that does not show up in the 38% investment-grade statistics. We've been playing in the area that we've identified coming out of the strategy sessions that we alluded to in the past. Are we as focused on some of the higher-yielding products that our inherited team from VEREIT was focused on? Potentially not. Are we going to do everything VEREIT was acquiring as a standalone company? Probably not. But we are trying to create a team that we truly believe will be complementary to ours, and now it's one team that is going to be able to play across the credit spectrum and be able to be an incremental source of acquisitions for us going forward. So, there'll be quarters where we do more than 38%. In fact, we've done up to 50% or 60% of investment-grade, and then there'll be other quarters where we don't. I don't want you to put too much importance on this headline number of how much investment-grade we're pursuing because, as I've said, that's a by-product of our strategy, not what drives it.

Great, appreciate the thoughts and clearing that up. Christie, not to beat a dead horse, we've talked about it over the last quarter too. I’m really still a little surprised that there hasn't been a recognition of revenues from the movie theater side. You pointed out a number of the positive industry dynamics that the industry is experiencing here. So is it just more timing? And it sounds like certainly right now there isn't any of that in your 2022 guidance. So just trying to square your comments with the lack of recognition or any sense of timing on that.

It really, in a nutshell, is timing. We did in the third quarter experience payoffs according to our deferred arrangements, the handful of theater properties, and they're back on accrual accounting. And we'll continue to evaluate on an asset-by-asset basis. We still have remnants of COVID out there. We want to make sure that we're evaluating this, not only on an asset-by-asset basis but also just in terms of what's happening on a macro perspective. So, more time, and we will be back to report to you.

Okay, fair enough. Thank you.

You bet, Haendel.

Hi everyone, congrats on the merger and all the recent progress. Maybe digging a little deeper on the pipeline, I'm wondering if you can talk about the difference in what you're interested in abroad versus the U.S. I think you mentioned that the abroad pipeline might be a little bit narrower?

Yeah, Caitlin, it's just not as developed. It's driven partly by being land-constrained. You don't have as many freestanding triple-net opportunities in terms of various industries and various tenants being in that space. Obviously, the size of the actual market is 2x what we have here in the U.S., but the number of industries that lend themselves to sort of this triple-net concept are a bit narrower. We've already talked about grocery as being one of the areas that we'd like to focus on. Hold improvement is another area. But it is very unusual to find some of the other industries that we're exposed to on the retail side being available in mainland Europe. This isn't the constraining factor because I think we put out some numbers to share how much bigger the actual market is—the addressable market in Europe lends itself to net leasable investing. It really is more of an unusual situation.

Got it. Okay. And then given your larger size now, do you expect there to be any change in sourcing over the next year? As a result of that, do you think there will be any meaningful change in your acquisition cap rates?

I hope so. I absolutely believe that with the newly expanded team, including folks from what was VEREIT, we will be able to increase our run rate on the acquisition front, and we will be able to cover the credit spectrum a lot more precisely and acutely than we were able to do on a standalone basis. That should result in not only higher sourcing but getting more transactions over the finish line. Based on everything that we've seen and getting to know our new colleagues better, I absolutely believe that is going to play out next year and beyond. But time will tell. That is our expectation.

Okay, great. Thank you.

Absolutely.

Hey, congrats on the VEREIT merger. Just two quick ones from me. The first is just going back to acquisition, and I think you've talked about the $50 billion-plus enterprise value having less concentration risk. So, I guess the question is really, is the team doing anything organizationally different to try to source those deals or is the point that historically when those yields have come up, you've had to pass on them, but now you could take a look at it?

It wasn't that we were passing on deals, Ronald. It was more along the lines of— if you look at some of our industry concentration, they were starting to creep into double-digit percentage ranges. The complementary nature of what we are inheriting from VEREIT, I believe, helps us on a couple of industries. If you look at a few of our largest industries like convenience stores and groceries, all of those concentrations are pro forma, and it’s actually going to come down. It gives us more capacity to aggressively pursue opportunities that we find incredibly compelling to try to finalize. Second, being a much larger company, and this is a more recent motif—two years ago, maybe a little bit longer, was the first time I heard of a billion-dollar sale-leaseback opportunity in our space, and it was on the retail side. We've never seen opportunities of that size. Even if we had some prior exposure to the client doing a billion-dollar transaction, we can see that pushing the concentration risk issue. Now, we are 1.3 to 1.4 times the size we were in the past, and we expect to be less of an issue. The size of sale-leaseback opportunities that are now in play are billion-dollar opportunities. We haven't really seen much move over the finish line, but to us, it’s exactly the type of transactions we would like to show up for. We can provide multi-billion-dollar sale-leaseback opportunities that were not able to pursue aggressively in the past, so I think that will be one of the biggest benefits.

Yes. Sorry about that. Great. My second question was just going to 2022 guidance. I appreciate the transparency, and I can appreciate these are preliminary numbers. When I think about the AFFO guidance range, can you maybe share what that assumes regarding same-store rent growth and the assumptions for reserves for credit losses?

We provided a couple of numbers when we came out with this. The point of coming with guidance at this point in the cycle, which is non-traditional for us, was largely driven by this acquisition of VEREIT. There was a lot of uncertainty around what does pro forma Realty Income really look like post separation of the office assets. In terms of other assumptions like same-store rent and other inputs, it largely aligns with what we've done in the past. You should assume it to be the same 1% that we usually target.

Great. Thank you.

Sure.

Hi, Christie. With the acquisitions in Spain during the quarter, could you talk about what you learned from the transactions and how this impacts your approach in Continental Europe going forward? I think in recent calls, you guys have spoken about trying to learn the local market, and there's a lot of nuance to it. So, maybe you could just provide some color around your experience there.

Sorry. Are you asking us about our filter for entering new markets? Is that the question, Brent?

No, sorry, Sumit, it's more just what did you learn specifically from the process itself as far as the nuances of the deal structures or negotiations? Just anything about the market that you picked up.

Brent, I'll tell you honestly, we did a lot of homework before we actually went into any particular market. We looked at transactions that have taken place in the past; we tried to understand the nuances of the structures; we considered the tax implications. A lot of the homework was done before engaging with potential clients or the advisory community to start pursuing transactions. We weren't overly surprised by the structure of the deals that we've been able to finalize. The one thing that has surprised me personally is the volume of business. I do believe that we have been able to create these relationships that have cemented and translated into subsequent transactions much more quickly than anticipated. This is very much a relationship-driven market, which we had anticipated but not to the extent we’ve seen. They're looking for long-term partners who are not in the market to flip assets, and that's exactly in line with how we believe in generating long-term value for our investors. The certainty of closure seems incredibly important, far more so than perhaps here in the U.S. Here, certainty of closure is still important, but they're much more price sensitive than in continental Europe and the UK. So, reputation, size, and scale— the fact that we do what we say seems to be weighed a lot more significantly in Europe than what we anticipated. That’s where the surprise came in, not in the durations of lease or the cap rates or the growth we find embedded in these leases; a lot of that was known to us before we went into these markets.

Okay, great. That's it from me, guys. Thank you.

Sure.

Good afternoon.

Hi, John.

Just looking at leasing spread renewal and re-leasing assets, the third quarter was well above what, I guess, even recent historical levels. Do you think that above 100% recovery is sustainable here, or is that maybe more a reflection of where we are in the macroeconomic cycle given the pandemic?

John, that's a good question. If you're asking me, can we do positive 7% without capital investments every quarter going forward, I think the answer is probably no. But I do think that over the last eight, twelve, and even during the pandemic, the kind of releasing we've been able to achieve without a bunch of capital investments is a testament to the quality of our portfolio. Much more importantly, it's a testament to the asset management team under the tutelage of Janine, who has helped generate these numbers. If you look at the trend over the last 3-4 years, we have generally achieved over 100% releasing spreads. This includes not just clients who renew an option, but also new clients that we’re bringing in, either into empty buildings or buildings about to go empty. So, this is the complete picture of what we've been able to accomplish. That is one of the key points we've been trying to convey: our business is set to operate as a seven-year world business. Much of the value is either going to get created or not. We've anticipated this and built out our asset management team anticipating being able to generate the kind of results we’re posting on a quarter-by-quarter basis. We feel very good that we usually target above 100% each quarter, and we have been able to do far better than that. I will leave it at that.

Okay. And then switching gears a little bit back to international, I think we can be pre-pandemic if you look at acquisitions in the UK versus the U.S. The UK was always significantly lower than U.S. acquisitions, and that spread has kind of disappeared. Is that a factor you think of macroeconomic pushes and pulls, interest rates, etc., or is that more reflective of different kinds of investments that you are targeting either internationally or domestically?

It is certainly the latter. If you're looking at grocery businesses here in the U.S., there's been significant cap rate compression. The U.S. market has moved closer to the UK market rather than the other way around. There are differences in lease structures, etc. What you see as that headline cap rate seems to be very close. There is variability from quarter to quarter. In the second quarter, we had slightly higher cap rates associated with international, and that was a function of the assets we acquired and the length of the lease terms, which translated to higher cap rates. But by and large, the spread, which considers both the cap rate and the cost of capital, is very similar right now in both these markets. It's partly driven by the fact that we are playing in a much narrower industry spectrum in Europe. We have been doing a lot more industrial here in the U.S., so that balances out and yields the number you see as the headline number in our supplemental.

That was very helpful. Thank you very much.

Thank you.

Hi everyone. Quick question on the acquisition volume this year. Hi, Christie. When you look at what's driving the upside, is it more on the sale-leaseback side or is the developer takeouts and broker deals? Just trying to get a handle on where the upside is coming from.

It's a combination of all forms of development. We are doing takeouts; we are financing 100% of the developments. The one common thread is that in most cases, there's a lease in hand. There might be retail assets as well. But on the retail side, it was 93% occupied, and that’s largely driven by repositioning we’re doing. We don’t quite have the lease in hand for that one particular unit, but otherwise, it's all built-to-suit. We play across the spectrum, providing all of the development funding and doing takeouts.

Okay. And then when we look to next year's guidance, you do have about $750 million of high coupon debt in 2023 that is due. Is it safe to assume that's not in the number, or is prepayment of that included?

It was 93% occupied, largely due to the repositioning efforts we are implementing. We don’t currently have the lease for that specific unit, but everything else is built-to-suit. We cover a wide range of areas, providing all the development funding and managing takeouts. When considering next year's guidance, there is about $750 million of high coupon debt due in 2023. Can we assume that amount is excluded from the projections, or is the prepayment of that debt accounted for?

Okay. Thanks for taking the questions.

Thank you.

Thanks, Wes.

Hey, it's Michael Bilerman here with Katy. I want to come back on the pipeline. Just come back on the $5 billion for next year. And I take your comments are trying to be conservative; it's early, you want to see what the combination of the teams can do. But how did you come up with a $5 billion? You didn't pull it out of thin air; there has to be some rigor to come up with that. So can you just walk through sort of the analysis you went through to come up with that $5 billion?

Sure. As we become more comfortable with the strategy we're currently executing, it gives us a lot more confidence to say that this is a product we're seeing. This is the translation rate on that product on the sourcing numbers. We feel confident given the team and infrastructure we have in place that we’re going to be able to accomplish what we’ve posted. This year was interesting; we had a very healthy pipeline, just like today, but it was post-pandemic, and we didn’t know how things would play out. We felt good about saying $3.25 billion, which we revised a couple of times. As we're getting comfortable with the new markets we're entering into and the sourcing volumes we're seeing, we feel very confident issuing numbers for this fiscal year. Earlier, we assumed about 20%-25% international, and today, that’s closer to 30%-35%. We’ve built out the team on the international side, now we inherit a group of veterans from this acquisition, so that’s how we determined that number.

Hearing that would sound extraordinarily conservative, given all the arrows you have in your quiver to execute additional acquisitions. Especially given your other comments about being a bigger company allows you to take on different risks, which arguing being a big company if you did a billion-dollar portfolio, and had $100 million of assets that you didn’t want, well, $100 million or $50 billion isn’t that much. How does that play into your thinking about deal flow from here? In the past, we had talked about large tenants that have a lot of real estate; you are much better equipped today to do those elephant-hunting types of transactions. How active are you in going to those corporations with real estate on their books where you can do a direct deal on a much larger scale? Can we expect that to be a much bigger part of the story going forward?

In the past, we would consider partners when we were presented with multi-billion-dollar sale-leaseback opportunities. We have had inbound requests from investors that wanted to participate in these one-off transactions and larger transactions outside the public view, but we largely stayed away from that. We felt the transactions we were seeing in the market were manageable for us. We didn’t have to pursue partnerships aggressively. The need for that has diminished further following this acquisition. However, we had discussions with investors who wanted to participate. We've largely stayed away from any partnership opportunities until now because we felt like the transactions we were seeing in the near term could be handled entirely on our own. Empirical evidence suggests that the need for partners has diminished even more given this pro forma VEREIT transaction, and I believe our willingness and desire to pursue potential clients that we want to engage with is a lot higher today, given that the concentration issues we could have faced are somewhat muted now. Those types of discussions are coming to the forefront of what we do.

Okay. And then the second topic—last topic is regarding the office. When you announced the transaction, there were discussions about not having a plan to deal with those assets that you didn’t want on your balance sheet. You said you would pursue two paths: you’d consider a spin-off as a backup option and a sales process. Can you talk us through what led you down the path of an office spin and thinking about the dis-synergies from a G&A perspective? How did you evaluate the value delivered to the combined shareholder base versus a sale and taking cash? Why spin instead of sale?

When we discussed the separation of the office assets, we were clear with the market that we would pursue either a spin-off or a sale. We concluded that the spin-off was a far better option given where we were coming out on the sales side than not. We thought the office assets had a thesis that made sense, and there are some tailwinds in that particular sub-sector. Given the success we've been able to achieve over the last couple of years, you look at that and you start to see what they can do with that portfolio going forward. From an alternative perspective, this seems like the best option to pursue despite selling the assets would have been an easier step for Realty Income to take. But we did both parallel efforts, and this path yielded the superior risk-adjusted outcome for us and that's the reason we pursued it.

Okay, thanks for the time.

Sure.

Yeah. Hey guys. Hope everyone's doing well. Now that the VEREIT merger's behind you, I'm curious you added a bunch of teammates; are there any skills that were brought in that would help you widen the aperture?

Yeah, Josh, that's what we were—sorry, I didn't mean to interrupt. Go ahead.

No, no, please, please.

Through this acquisition, we’ve inherited a team that can cover the entire credit spectrum, which is a huge convenience and assist in understanding higher-yielding and lower-yielding assets. In addition, there will be data analytics and process re-engineering work featuring talented individuals from their team that will also add tremendous value as we build on and execute our business opportunities. Honestly, I’m proud of the team we’ve inherited, and it's a substantial addition of over 100 people that will help us manage more than 3,000 properties effectively.

Got it. And one other question relates to dividend strategy going forward. I'm just curious to hear your thoughts on how you view your payout ratio and retained earnings.

Our payout ratio is in the high 70s today. We will always be the monthly dividend company; it took us over 25 years to become part of the Dividend Aristocrat Index, the S&P 500 Dividend Aristocrats. This is core to our strategy going forward. And so, in years where we can grow 9.5% or 9.2% as at the midpoint of the range we've just shared with you, that will just help grow our dividends in the future. There will be no change to that strategy of annual growth on the dividend going forward. To emphasize, the core dividend growth is critical to Realty Income, and nothing we've done either recently or in the past will change that.

Got it. Thank you.

Hello. With 85% of your leases having some type of contractual rent increase, can you remind us what kind of increases you obtained on the European leases versus domestic? And across the entire portfolio going forward, what might average weighted rent increase look like versus what it is now?

Yeah, Linda, I’m not going to give you precise information. I think it is strategically important for us not to be that precise about growth by geography. I will say that 85% of our leases have contractual growth, either in the form of fixed growth, CPI adjustments, or percentage rent clauses into the contract. You can continue to underwrite to 1% same-store growth for our business going forward, and we will update you as warranted, but for right now, that is the assumption you should have for your models.

Thanks. How should we think about the pacing mix of capital raising activity in 2022 as you move forward with a plus $5 billion acquisition run rate?

I think, Linda, you can expect that to be consistent with our personal approach from this year, funding our business while continuing to pursue a cost-competitive capital strategy while maintaining our net debt-to-EBITDA.

Thank you.

Good afternoon, everybody, thank you for taking my questions. To summarize, a lot of the questions have been addressed, but I'd just like to ask, Sumit, given the scale of the company at this point and where your credit rating is, I'd like to inquire about your conversations with the rating agencies post-merger. Have you gotten any flexibility or indication from them that you have more leverage on your side to maintain those very high credit ratings?

I'll share the headline, but I'll let Christie answer this point because she actually had the conversation, along with Jonathan with the two rating agencies. They were supportive. When we went back after our third quarter announcements and spoke with them, they were complementary. They saw the capital raised and that we front-loaded the funding of our acquisition pipeline. They continue to reaffirm our current stance of A- and A3 rating and a stable outlook. I don’t see us being put on any sort of a negative watch or otherwise. We’ve been transparent and shared all analysis with the rating agencies and feel confident that they will continue to support us and maintain us at this level.

I was going to say it the other way. I’m wondering whether the scale of the company and the diversification of the portfolio will allow you to take on more leverage.

That’s a good question, Chris. I don't know the answer to that, and it's difficult to enter into hypotheticals with the rating agencies regarding this situation. They can be somewhat of a black box. We didn't change our leverage profile when we were on this way up. This lends credence to your comments. But we can't expect that, and the truth be told, we are happy with our rating. I don't know what the incremental benefit would be in achieving an Aa2 rating; it doesn't seem significant compared to gaining A- compared to BBB+. It’s a good question and one that now that you've raised it, we’ll pose to the rating agencies to figure out how they’re thinking about this.

Just one last question, regarding how you want to finance your business, mentioned that European rates are more attractive than U.S. for financing. Would you consider financing at a higher level relative to asset base in Europe than you do in the U.S. from a debt-finance perspective? And how high would you go?

Yes, Chris, we’ve been very clear about what the limiting factor is for us in Europe. We want to use domestic capital to finance as much of our acquisitions as possible. However, the limiting factor will always be the asset value. One of the biggest advantages we have is that we can raise debt in any geography. In an environment where we see rising 10-year U.S. Treasury yields expected, we could do a much larger portion on the unsecured side as long as we continue to grow in the UK or mainland Europe. However, the constraining factor will always be what's on the left side of the balance sheet and whether it supports the raising of finance. Could we be more leveraged in Europe than the U.S.? Absolutely. That’s one of the big advantages of why we did this.

Super. That's all I had today. Thank you so much.

Of course, Chris. Thank you.

Hi, Spenser.

Hi. I know you spoke about development earlier; can you just more broadly talk about how the development economics vary between the U.S. and Europe? And if possible, can you provide some color around what kind of deals you're expecting on the one UK development you have underway?

Hi, Spenser. We're going to stay away from speaking about specific transactions; we just don’t do that. I will say that we are able to achieve slightly higher yield on development projects than we would on assets ready for delivery. The range might be anywhere between 25 to sometimes, in a few cases, 75-80 basis points. It used to be north of 100 basis points not too long ago. But for us, we are a yield-driven business. Every incremental yield is a positive for us, Spenser.

Thank you, Spenser.

Thank you, everyone, for coming, and we look forward to seeing many of you at Nerige. Goodbye.