Realty Income Corp (O) — Q3 2022 Earnings Call Transcript

Thank you all for joining us today for Realty Income's third quarter operating results conference call. Discussing our results will be Sumit Roy, President and Chief Executive Officer; Christie Kelly, Executive Vice President, Chief Financial Officer and Treasurer; and Jonathan Pong, Senior Vice President, Head of Corporate Finance. 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. I will now turn the call over to our CEO, Sumit Roy.

Thank you, Andrea. Welcome everyone. At Realty Income, we pride ourselves in having a consistent and dependable business model. For 53 years as an operating company, we have persevered through a variety of macroeconomic climates and our track record of stability notably during periods of volatility is particularly relevant during current times. We sit here today well positioned and operating very well across all areas of our business. We are grateful for all of our team members who make the success possible. To start off, we capitalized on opportunities to bolster our balance sheet in the third quarter, including raising over $2 billion of equity on the ATM with approximately $700 million of proceeds received during the third quarter as well as over $1.3 billion remaining subject to our settlement on a forward basis in alignment with our capital strategy. In addition, we issued $750 million of 10-year senior unsecured notes in October to further increase our liquidity. Between cash and cash equivalents, our availability under our credit facility, our liquidity as of the end of the third quarter was over $2.5 billion, which when combined with the $1.3 billion of our unsettled forward equity and approximately $744 million in net bond proceeds equates to liquidity of approximately $4.6 billion had the forwards and net bond proceeds being received at quarter end. Moving on to acquisitions. During the quarter, we acquired approximately $1.9 billion in high-quality real estate, bringing us to approximately $5.1 billion in acquisitions year-to-date. A significant portion of the properties purchased in Q3 were part of portfolio deals or large transactions. We believe these deals were accessible to us because of our size, scale, relationships, ability to close, access to and cost of capital together with our research and technology-driven analytic capabilities. For Realty Income, our competitive advantages allow us to design and execute on strategies that benefit all those we serve including our clients. The pending $1.7 billion Encore Boston Harbor transaction, which we continue to expect to close this year remains an example of this dynamic. Based on our current total portfolio annualized base rent, the transaction would comprise approximately 3% of our total portfolio annualized contractual rent, once closed. Further leveraging our international capabilities, we made our advent into Italy last week investing approximately €165 million in seven high-performing wholesale clubs, operated by Metro AG in major Italian cities like Rome and Florence. Metro is a pan-European leader in the wholesale club industry and operates almost 700 stores across Europe. Metro is publicly listed and investment-grade rated, and has continued to perform well during and since the pandemic. We are delighted to add them as a client and hope we will be able to add to this initial portfolio over time. During the third quarter, we did experience cap rate expansion registering a 6.1% cash cap rate on investments, which compares favorably to the 5.7% cap rate we realized on our investments in the second quarter. This resulted in a third quarter investment spread of 165 basis points based on actual capital raised, which is higher than our year-to-date total of 161 basis points and above our historical average. As we move towards year-end, we continue to see cap rates push higher as capital costs increase. This is consistent with the historical correlation we've come to expect, which has tended to preserve investment spreads as the market adjusts. Transaction flow remains strong with sourcing volume totaling approximately $18 billion this quarter, bringing year-to-date sourcing volume approximately $78 billion. We remain selective as we have acquired approximately 6.5% of sourced volume year-to-date. The international market continues to be an important part of our strategy and it remains an active component of our volume, representing approximately 33% of investment volume in the third quarter. Capital recycling continues to be a strong component of our funding strategy, which also has the dual purpose of culling noncore properties from the portfolio. During the third quarter, we sold 34 properties generating net sale proceeds of $142 million, at an unlevered IRR of 12.8%, illustrating the full cycle attractiveness of owning net lease real estate under long-term leases. We intend to continue to act opportunistically to dispose of assets at moments in time when we can obtain attractive risk-adjusted returns. In addition to the disposition of properties on our balance sheet, we also sold our interest in seven properties owned in an industrial JV that we assumed as part of our VEREIT merger. The gross purchase price totaled $905 million, at a low 4% cap rate. Our share of net sale proceeds was approximately $113.5 million. Our core portfolio continues to perform and by and large our clients have generally continued to perform very well despite the cyclical market changes and shifts in consumer behavior. A point to note, as previously publicly announced one of our clients Cineworld commenced Chapter 11 bankruptcy in September. Despite being one of its largest landlords, Cineworld represented only 1.5% of our total portfolio annualized base rent as of Q3. We'll continue working closely with Cineworld as this process continues towards resolution. For some color regarding theaters, for the third quarter 2022, we collected approximately 85% of the contractual rent across our theater portfolio, as Cineworld Group plc was not yet required to pay rent for the month of September. For the month of October 2022, we have collected 100% of the contractual rent across our theater clients including Cineworld. For some specifics, our Cineworld portfolio consists of 41 properties, 17 of which are subject to a single master lease agreement and 22 of which have been accounted for under cash basis accounting since the third quarter of 2020. Through September, we have recognized $23.5 million of cumulative reserves on these properties, representing primarily contractual rent and expense recoveries that have not been collected, dating back to the beginning of the COVID-19 pandemic in 2020. These 22 properties on cash basis accounting currently account for approximately $1.6 million of monthly contractual base rent or 40% of our total exposure to Cineworld. Based on current public information and our internal analysis, we continue to believe our portfolio of Cineworld assets are generally comprised of the stronger performance in the operator's portfolio. Our locations are freestanding, single-tenant assets, typically with large land areas and close proximity to population centers, supporting potential conversion to residential, industrial or life science uses. We have received reverse inquiries from multifamily and industrial developers exploring opportunities on these sites. We believe there is alternative and adaptive reuse potential if Regal were to vacate any locations as part of bankruptcy. Moving on to some of the most important key operational metrics, delivering value that continue to demonstrate a consistent well-positioned real estate portfolio. At the end of the third quarter our occupancy was 98.9%. In Q3, we released 169 leases and achieved a rent recapture rate of 108.5%, bringing our year-to-date recapture rate to 106.7%. As we look forward, less than 4% of our contractual base rent comes due through the end of 2023, providing strong visibility into our near-term portfolio performance. At quarter end, approximately 43% of our portfolio's total annualized contractual rent was generated from investment-grade rated clients. Our properties leased to clients in our portfolio watch list represented less than 4% of our portfolio's annualized contractual rent. Lastly, our same-store rental revenue increased 1% during the quarter and 2.4% year-to-date and we continue to expect full year same-store growth to be approximately 2%. At this time I'll pass it over to Christie, who will further discuss results from the quarter.

Thank you, Sumit. Put simply, it was another productive quarter for us. In the third quarter our business generated $0.98 per share of AFFO, representing 7.7% year-over-year growth. Our net debt to annualized adjusted EBITDAR was 5.3 times or 5.2 times giving effect to the annualization of net investment activity during the quarter. These ratios do not reflect the $1.3 billion in outstanding equity forwards we had at quarter end. As Sumit previously mentioned, we were both active and prudent in our capital-raising efforts since the end of the second quarter. In addition to raising over $2 billion during the quarter at an initial weighted average price of approximately $68 per share, subsequent to quarter end, we completed a $750 million bond transaction, the majority of which served as a synthetic euro offering to take advantage of favorable foreign exchange dynamics, while also allowing us to return to the US dollar public fixed income market, which we last accessed in 2020. In conjunction with this offering, we executed a $600 million to euro 10-year cross-currency swap, resulting in the receipt of approximately $612 million in euro proceeds, an effective fixed rate euro-denominated semiannual yield to maturity of 4.7%. Additionally, giving effect to $500 million of interest rate hedges, which were terminated with the operated, we generated a $72 million cash settlement gain at pricing, which when amortized over the 10-year tenure of the note is expected to result in an effective semiannual yield to maturity of 3.93%. Financial flexibility has long been a hallmark of our strategy and our ability to move between various financing markets given our international capital needs is a competitive advantage. As previously reported in the third quarter, we upsized our US commercial paper program from $1 billion to $1.5 billion and established a euro commercial paper program with a capacity of $1.5 billion. The combined $3 billion commercial paper program, which is backstopped by our multicurrency $4.25 billion revolving credit facility, gives us the flexibility to efficiently match fund our short-term funding needs in various currencies at much lower rates than comparable US facility borrowings. As we look forward, we have limited near-term refinancing risk as only $23 million of mortgage debt comes due through the end of 2023 and our next unsecured debt maturity is not until 2024. With continued stable and consistent results in the quarter, we tightened our AFFO guidance range by $0.06 to $3.87 to $3.94, maintaining the midpoint at a 9% year-over-year growth rate, consistent with what we initially provided a year ago. As the monthly dividend company Realty Income's dividend will remain sacrosanct to our mission. This is a testament to our confidence in the time-tested consistency of our business model, supported by a conservative balance sheet and diverse real estate portfolio leased to clients that are leaders in their respective industries. In September, we increased the dividend for the 117th time and for the 100th consecutive quarter, representing a 5.1% increase compared to the dividend declared one year ago. We are proud of these accomplishments and the work our talented colleagues perform every day to help drive this consistent track record. Earlier this week, we celebrated the one-year anniversary of our VEREIT merger. We've grown together as one team over the last year and I'm pleased that we remain on track to realize over $50 million in run rate annual cost synergies that we estimated when we announced the merger. And with that, I would like to pass the call back to Sumit.

Thank you Christie. Our strengths have been accentuated in this quarter's result. While we cannot control the macroeconomic forces that periodically introduce volatility in the capital markets, I am regularly reminded that the resiliency of this team and the inherent stability of our business model allows us to look to the future with confidence. I'm pleased that we are able to lean into market conditions when it's advantageous to serve our shareholders, and I believe that the best is still ahead of us. At this time, we can open it up for questions. Operator?

Hey, good morning out there, everyone. Cap rates on acquisitions were up 50 basis points quarter-over-quarter. Looks like some of that's related to the mix of industrial and investment grade, but can you talk about how much of that was underlying market cap rates moving? And was there a particular goal to pursue higher cap rates to preserve accretion?

It's more about the former than the latter. We are certainly observing changes in cap rates. If we evaluate the environment at the start of the year and compare it to the cap rates we are witnessing today, particularly in the third quarter, retail cap rates have increased by approximately 100 basis points. This reflects two extremes of the credit spectrum. For high investment-grade grocery assets, which were trading in the low four cap rate range at the beginning of the year, we notice they have shifted significantly, now hovering around 5.5%, possibly even 5.6%. That's about a 150 basis point increase. Conversely, higher yielding cap rates that had compressed notably over the past few years also experienced a similar shift. The middle range has seen movements of around 100 basis points, contributing to the realized cap rates observed in the third quarter. Transactions don’t happen spontaneously; we initiated discussions with our potential clients regarding the movement we were observing in capital costs, which were quite severe and immediate. Our established relationships and closing capabilities allowed some institutional clients to experience similar trends and adjust cap rates accordingly to support their business activities. This adjustment is reflected in the 40 basis points increase in cap rates that we realized in the third quarter. However, timing plays a crucial role. For instance, a gaming asset in Boston set to close in the third quarter will influence the overall cap rate as it’s associated with a 5.9% cap rate. Thus, the timing of when transactions are contracted and closed greatly impacts quarterly results. Overall, we are witnessing noteworthy movement in cap rates, similar trends are observable in the industrial sector. Industrial cap rates have also shifted substantially, a trend that started earlier in the year. Initially, I mentioned a potential movement of 25 to 50 basis points following Amazon's announcement that it would no longer be a significant purchaser of industrial assets, which previously represented about 20% of the volume. This shift led to movement on the industrial side that persisted into the second quarter. Currently, even though we mentioned selling in the low 4s, similar assets we are pursuing are now around the 5.5% range, indicating clear movement. We hope this trend continues positively over the coming months. Our portfolio and pipeline reflect this reality.

Okay. Appreciate the detailed answer. Christie, I was hoping you could walk through the puts and takes on the new guide. Obviously, you had headwinds from FX and from higher rates. I'm curious, what the offsetting factors were that kept the midpoint the same. Thanks.

I think Brad, you captured the headwinds together with the strengthening US dollar. I think in terms of where we see opportunity, is first as it relates to the determination on our AFFO per share, is the overall developments and as it relates to our clients that are on cash accounting. I just want to note that for Regal, we have no change associated with the status of Regal and in the midpoint of our guidance are expecting full collection. A couple of other things is also just our access to the international borrowings, which are a nice tailwind and you can see that demonstrated in what we were able to do with the euro commercial paper program. And as Sumit articulated, our relationships with clients, our ability to pivot in the marketplace, together with our strong pipeline and the timing of the Encore transaction, which could be a positive or a negative. Hope that helps, Brad.

Yes. Thank you.

Hi, good afternoon. I'll start with my boilerplate question for the quarter, and certainly appreciate the attractively priced capital you guys were able to source in 3Q, but I'm curious how you view your current weighted average cost of capital and what kind of spreads you've been able to achieve here quarter-to-date.

Yes. So, the spread we were able to achieve third quarter year-to-date was right around 161 basis points and this is based on actual capital raised throughout the year. And for the quarter, it was closer to 165 basis points. One of the things I'll point to is that in our investor deck, I believe it's Page 26, we do lay out precisely how we calculate our cost of capital. And there are basically three components to it, one of which is the free cash flow that we are generating, as well as the cost of equity loaded for the cost of raising that equity and our bond prices. But there was a strange thing that played out in the third quarter, and I don't know if I've got this fact 100% right, but we reached a 52-week high as well as our 52-week low during the third quarter. That was the level of volatility that we experienced, and we will call it luck, call it Jonathan Pong doing his thing, we were able to raise a lot of our equity capital on a forward basis with an average price of $68, and that's $2 billion worth of equity 700 of which we obviously was able to close and settle at the end of the third quarter and $1.3 billion of which we will settle at the end of the fourth quarter. And so that's the reason why I want to be very precise around the actual realized spread versus what traditionally has been a calculation of average WACC over a given period. This is the first quarter where we felt like there was a massive diversion precisely driven by the volatility that I just spoke about. But yes, that's how we calculate our WACC.

That's helpful. And so given the fact that cap rates in general are starting to move higher, but probably not as quickly as the cost of debt. How are you thinking about acquisition volume as we move into 2023? Is it time to maybe tap the brakes, sort of keep the pace, or do you think there's going to be more opportunities to potentially even accelerate the pace?

Yes. R.J., it's going to be a function of how quickly the cap rates adjust. Clearly, there are mechanisms available to us on the capital side and on the financing side that we are going to avail of, but that's limited in terms of what is the ultimate spread that we can realize. And we are being incredibly disciplined around making sure that the team is pivoting to hurdle rates that we need to achieve on the cap rate side in order to continue to maintain spreads that we feel like represents the right spread for the kind of risk that we are taking based on the acquisitions that we are pursuing. I have been pleasantly surprised with how quickly cap rates have moved. Based on some of the transactions that we are seeing in our pipeline, we are very optimistic that we'll be able to continue to maintain the spreads that we have historically maintained, and we see that over the continuing next few quarters. But timing will be of the essence. Like I said, if there are certain transactions that we entered into, especially on the development side, that was 12 months ago, those are going to not be quite as accretive as transactions that we are entering into today, which will potentially close in the fourth quarter and some of which will close in the first quarter that have spreads that are more in line with what our historical spreads have been. So timing is going to be of the essence in terms of what we report at the end of a given quarter.

Make sense. Thank you for the color.

Thank you, R.J.

Hi. Good afternoon. Sumit, deal sourcing is still significant, but it's also slowed each quarter in 2022 even while potentially casting a wider net internationally. What are the drivers of that trend? And do you expect it to continue that way into Q4 in 2023? And how might that declining investment opportunities impact acquisition levels and cap rates?

Yes. It's a good question Greg. And it goes back to having sticky sellers. Sellers who haven't quite embraced the changing cost of capital environment, who are hoping for this to have a shorter duration disruption and starting to recognize that given what the Fed is doing, given what they're seeing on the inflation side that this may be a longer process than what they had anticipated. I think that is part of the reason why you saw a tailing off on the sourcing side. We were averaging around $30 billion per quarter. Third quarter I would still claim was quite robust with $18 billion worth of sourcing, one-third of which was from the international market. So on a relative basis, yes, there was a bit of a slowing down and it's largely being driven by the time it takes for sellers to adjust to the new environment. It really is a story of those that are institutional sellers. They are able to adjust to it a lot quicker than some of the non-institutional more private owners of real estate for whom it has taken and will take a little bit more time to adjust.

Great. That's fair. Then just going back to the portfolio deals or transactions that you mentioned in your opening remarks. Can you provide a little more detail on the size of some of those deals, asset types and whether that's maybe a trend that you expect us to move into maybe that seller is just more willing to accept the current financing environment for what it is?

Yes. I think, the way I'll answer that question is to say in large portfolio deals, which tend to be owned by institutional owners, they're far more receptive to the changing cap rate environment and far more accepting of the changing cap rate environment. It will come as no surprise to you that over 70% of what we did were portfolio deals in the third quarter. It should also come as no surprise to you that some of the institutional owners of real estate were far more willing to enter into sale leaseback as an alternative source of raising capital, especially given their traditional sources of capital which may have been the leverage finance market or the high-yield market and the disruption that they saw there. About 50% of what we did in the third quarter were largely sale-leaseback transactions. I think that will give you a flavor for some of the transactions that we did. It was still mostly I want to say 94% was retail and there was about 4%, 4.5% of industrial assets that we did, but largely driven by what we are seeing on the retail side.

Great. Thank you.

Sure.

Good afternoon. Thanks a lot for taking my question. International acquisitions represent about 33% maybe lighter than what we've been seeing. The opportunity set just larger in the US now relative to Europe. Or are you seeing anything in Europe that you want to highlight in terms of pricing or sentiment, and recognize that also comes at the time when you moved into Italy?

I'll tell you Michael, we were doing north of 50% in the international markets in the first quarter. We did north of 50% in the second quarter. We are at one-third of the total volume in the third quarter. Again, it really is a function of the timing of close, etc. Having said that, I will say that the sellers in the US are far more accepting of the changing financing environment than perhaps in Europe. Europe is by country. It's a smaller market. It does take a little bit longer for things to adjust. Having said all of that, we are finding very good opportunities in the UK. And now with the advent into Italy I believe that momentum will continue. For precisely some of the reasons that I think we touched on during the second quarter, the debt markets are very unsettled. It has a very high cost associated with it. That's driving some of the transactions actually on both sides of the pond. But one of the additional dynamics that we are seeing play out in Europe is some of the pressures that some of the funds are feeling. In order for them to raise the appropriate level of capital, monetizing real estate is creating opportunities for us. I wouldn't read too much into it. There is still a very, very healthy pipeline that we have within Realty Income. The sourcing volumes continue to be yes, lower than what we saw in the first half but still very healthy.

Thank you, Sumit. As a follow-up, grocery is in your top 10 industries. Kroger is one of your top 10 clients. Does consolidation in the grocery industry give you any pause or change your opinion about kind of the future of this sector and as a product type within your portfolio? Thanks.

Sure, Michael. Whenever there's consolidation, it's important to consider who is leading it. In this case, Kroger is publicly announcing its transaction involving Albertsons. Kroger maintains a BBB rating, which was reaffirmed by S&P, although they did place it on a negative outlook. They are acquiring Albertsons, which carries a BB rating, but I don't see this as a negative development. There are various social issues to consider, but from a credit standpoint, this is actually a stronger outcome for us. The 30 basis points we have with Albertsons, which was previously assigned a BB rating, will now be elevated to a BBB rating. So, from a credit perspective, this isn't necessarily unfavorable for us, although it doesn't address other important concerns that are currently being discussed in the market regarding the feasibility of this merger. Generally speaking, not all consolidation yields positive results, as it largely depends on the unique circumstances involved.

Got it. Thank you very much.

Thank you.

Hey everyone. Just a question on the hedging, a lot of the ForEx volatility and interest rate volatility. Is that making it easier or harder for you to hedge cost effectively?

Hey Wes, it's Jonathan. The foreign exchange environment has certainly been volatile in the third quarter. I wouldn't say it's been harder to hedge. We're dealing with very liquid currencies for short-term hedging. It's challenging to predict where these rates might go, but the mechanics of hedging haven't changed. Looking ahead to the next 12 months, we are currently about 50% hedged on our earnings. We aim to reach a point where foreign exchange rates won't impact our quarterly earnings. We're very aware of this.

Got it. I want to discuss Regal. It seems like you're quite optimistic about the cash basis tenants, even in a challenging scenario. So my first question is, do you generally expect a positive outcome here? The second part of my question is regarding the master lease asset. Historically, do these arrangements typically remain unchanged, or have there been instances where they were negotiated for a modest reduction? What should we anticipate based on past experiences?

So Wes, there isn't one single answer that can address the master lease question. It is very much jurisdictionally dependent, depending on where the bankruptcy is playing out. In this case, I believe it's in Texas. It's a function of how they're going to interpret the strength of the master lease. But yes, having a master lease certainly does accrue certain benefits to us. It should be viewed as an all or nothing situation. But we can't guarantee that going forward. We'll see how it all plays out. Regarding Regal and the ultimate outcome, you read a fair amount of optimism into some of our prepared remarks and when we have answered questions directly. That is a true read. I'm not saying that Regal will continue to run 41 assets when they emerge from Chapter 11 but what I am telling you is the ultimate economic outcome on this portfolio, we feel very comfortable about. A lot of it has largely been driven by unsolicited inbounds that we have been receiving, even on some of the assets that we recognized to be not very good performers and recognizing that the best use for these assets perhaps may not be a theater asset going forward but something totally different. When you start to look at where these are located the amount of land in some cases north of 10 acres creating a mixed-use or multifamily makes it tremendous amounts. Value creation opportunities for us to partner with some of these developers can create a lot of value for us. Yes, it's going to take time, but we feel fairly optimistic that the ultimate economic outcome on this portfolio will be one that we will be very comfortable with.

Got it. Thank you very much for that.

Thank you.

Hey. I have a couple of quick questions. Returning to tenant health, you mentioned Regal, which was good to hear. Are there any other tenants of significant size, such as those affecting 50 or 100 basis points, that we should keep an eye on? Also, could you provide an update on the current reserve for bad debt year-to-date?

Yes, I can address the question about whether we have more than 50 basis points for any other clients besides Regal. The answer is no, we do not. Our total watch list accounts for less than 4%, specifically 3.9%. Regal is our largest client on this list, and while we do have a few other clients in the health and fitness sector, we feel generally positive about our overall situation. Now, I'll have Christie respond to the other part of your question.

In terms of reserves, Ron, total reserves are $33 million. Just dovetailing with what Sumit said in regards to the watch list and what we've already made publicly available, it's really primarily a story around Regal and the reserves that we have on the books associated with Regal.

Great. If you take a step back and consider the company's balance sheet in the current challenging capital markets, it seems this is an environment where you could excel, which you mentioned in your opening comments. My question relates to acquisition volumes and cap rates. I'm trying to understand your pricing power—how much can you actually ask for higher cap rates? Could we see an increase of 25, 50, or even 75 basis points in cap rates, given your advantageous cost of capital compared to others seeking it?

Ron, I don't want to exaggerate the situation. Just one additional competitor can come in and lower what is typically expected in terms of cap rates, which would keep them down. That said, if you observe the trend, it's clear that cap rates are changing quickly, faster than I anticipated. It's also true that our clients, with whom we have established relationships, have chosen to enter into contracts with us. Even after initially not having a contract, when they returned and informed us that their cost of capital situation had changed, they still opted to work exclusively with us for larger transactions. Fewer competitors who have the necessary capital to transact at acceptable spreads for their investors creates an opportunity for us. This represents relative progress. We have managed to influence cap rates, but it would be inaccurate to say that we will benefit from everything that happens in the future. That isn't the reality. However, we expect to perform better than average. I think that's the key point you can take away from my comments, Ron.

Great. Thanks so much.

Thank you.

Thanks. Going back to the portfolio transactions piece, your peers have pointed out that there's a trade-off between acquisition volume in cap rates. You can always drive higher volume on cap rates in the fives. But it seems like because of the ability to drive larger portfolio deals you can drive both higher volumes than them at higher pricing. So, I guess, could you point out how much of – how many basis points of pickup you can get on a portfolio transaction versus maybe a one-off single transaction deal? And how long you think, it will take for these higher cap rates to show up in the single transaction market?

Yeah. Harsh, that's a very difficult question. But if you are forcing me to answer that question, I would say, anywhere in the region of 20 to 30 basis points, 35 basis points. If that transaction size continues to be bigger and bigger, you're going to start going beyond that is how you should think about it. There is a dearth in this particular environment of potential buyers being able to write large checks, and that is our single biggest advantage today, along with the fact that obviously on a relative basis our cost of capital has held up. But it is going to be very much asset-by-asset, portfolio-by-portfolio discussion in terms of what is that delta between the one-off market and the portfolio market. In terms of how long is it going to take, I'll tell you that a Chick-fil-A – 15 year Chick-fil-A will still trade in the fours today. There is enough buyers – private buyers who can write a check for $5 million or $4 million who don't necessarily need to rely on the debt markets in order to do so. It's tough for me to – I mean, I saw this Chick-fil-A example literally a week ago, and I asked the team what is the ask and what do you think it's going to trade at. The answer was mid-4s. How long will it take for that to adjust? Who knows? The good news here is it helps us on the disposition side. If we have one-off assets that we feel like we can take advantage of this market we'll certainly do so. It's not a big part of our business. But like I said more than 70% of what we buy are portfolio deals. We continue to focus on that side of the business.

Thanks. And then just considering the timing of moving into Italy, you mentioned that cap rates in Europe haven't reacted as much as those in the US, and it seems like the economic outlook might be slightly worse for Europe tenants as in the US. Given that backdrop what caused you to enter Italy today? And I guess, more importantly, what prompted the debt swap that was swapped into euros which suggests that maybe you're expanding more into Europe?

Part of that swap was intended to finance our transactions in Europe, including the one with Metro, which we view as a fantastic opportunity. We started discussions about this transaction earlier this year or perhaps late last year. Italy is an interesting market; it has the fourth largest GDP in Europe and we believe there are opportunities for transactions with investment-grade rated operators who are looking for real estate partners. This is why we find Italy appealing. While we haven't disclosed the cap rates, they have been healthy, allowing us to capture acceptable spreads even in the current environment. It's important to note that while cap rates in Europe are adjusting slowly, the pain there may persist longer than what we expect in the US, which could create opportunities. We aim to be at the forefront to take advantage of these chances. Under Neil's guidance, our team is continuing to build on relationships in areas where we want to expand. This work is already in progress and will be vital for our growth. When we entered the UK in 2019, retail was not favored, and Brexit was a major concern. We completed deals during that time, and subsequently, cap rates compressed by 70 to 80 basis points or even more. We plan to be opportunistic, leveraging our competitive advantages to execute transactions where it makes sense. While we will be diligent and selective, we did not enter Europe to back away in tough times. On the contrary, we believe that the next 12 months in Europe will present us with significant opportunities.

Great. Thank you.

Thank you.

Hi. Thank you. Just a point of clarification. So in terms of the $31 million and the outstanding receivables from Regal, is that all factored into your reserve of $33 million?

From the perspective of the reserves, Linda, we took reserves on Regal as we had communicated of $23 million. There is another $30 million of outstanding receivables associated with Regal to clarify.

Okay. But the reserves you currently have for just the tenants on your watch list are $33 million?

In terms of the total, we have for the watch list is $33 million, of which $23 million is Regal. The remainder, as you would understand is primarily health and fitness.

Okay. Thank you. And then just in terms of the recapture rate, that was very strong the 108%, could you just talk about what's driving this overall? It has been strong pretty much all year.

Yes, Linda, I believe this reflects well on our team and our ability to manage more assets for our operators. There has definitely been an increase in switching costs for many of our clients. One competitive factor is that clients may consider building a new asset nearby, which they believe would yield better results. Given the inflationary climate and rising construction costs, the challenges associated with switching have indeed become more pronounced. The fact that we control 11,700 assets allows us to engage in more comprehensive discussions with clients, considering not just immediate needs but also longer-term solutions that can create mutually beneficial outcomes, leading to the re-leasing spreads we are seeing. I am pleased that we achieved a re-leasing spread of 108%, but I don't want to regard it as an anomaly. Historically, our figures have hovered around 100% to 101% net of re-leasing spreads. While this current figure is certainly higher on a proportional basis, it also highlights the current market conditions we are navigating.

Do you think this continues for next year?

In the near term, we can expect to remain within this particular range. One thing I want to mention is that in an environment like this, we will be more open to evaluating clients. This involves analyzing our portfolio to determine the best economic outcome. We may consider renewing with an existing client at a 5% increase, engaging with another client requesting a 10% reduction, or looking at the option of selling the assets and utilizing the proceeds in the current cap rate environment. After going through this decision-making process, including the potential repositioning of the asset, we will decide on the most favorable outcome. Over the last few years, the outcome has generally resulted in re-leasing spreads of over 103%, 104%, or 105%. However, it is possible that those spreads may drop back to around 100% or 101% since it might be more advantageous for us to retain an existing client, even if it means taking a slight loss. Nevertheless, I still believe that we will maintain a recapture rate above 100% over the next six to eight months.

Thank you.

Sure.

Thanks. Sumit, you talked about the volatility, obviously, in your shares, but also really across the space. At this point, there's some diverging multiples in cost of capital. Hoping to get your thoughts on M&A broadly within the sector and then your appetite for it.

Yes. Nick, if you can identify candidates open to discussions about mergers and acquisitions today, it could be a great opportunity to talk. I believe many management teams will be primarily focused on managing their businesses and ensuring they come out of this economic climate stronger, allowing them to pursue M&A transactions. In theory, mergers and acquisitions are definitely worth considering, particularly if it’s a 100% stock deal and doesn’t rely heavily on public market debt for financing. If your cost of capital is stronger, as it generally is for us, that is something we would find very appealing. However, it might be challenging, and I am speaking hypothetically here. It could be hard to see management teams from potential companies wanting to have those kinds of conversations in this environment.

Thanks. I completely understand that it takes two to make this work, but that’s helpful. I know we've discussed cap rates extensively. You mentioned the casino deal that is still set to close later this year, and I believe you indicated a 5.9% cap rate that was agreed upon earlier. Where do you think that cap rate would stand today? How much expansion in cap rates do you expect in relation to the casino cycle?

Yes, Nick, you cover all the gaming companies. What I'm observing is that they have all been repriced, and I'm unsure if we played a role in that. They are trading at levels where I doubt there will be significant movement from when we invested in the Encore Boston Harbor asset. I still consider it an outstanding asset. We evaluated it about a year ago with an expected EBITDA of around $210 million, and it is already performing at $250 million EBITDA. I still believe it has not fully stabilized, especially with sports betting being legalized. I wouldn't say that the 5.9% would be drastically different today, but we haven't encountered an asset like that yet, making it tough for me to provide an opinion on it.

Thanks. And where do you think it closes?

We are hopeful and that's one of the things that we talked about on the earnings guidance. We are expecting to close in the fourth quarter. That remains our conviction. But really as to when in the fourth quarter remains a bit of a question mark, but we still believe that it will close in the fourth quarter. I have a very high conviction on that front.

Thank you very much.

Thank you.

Good afternoon.

Hi, John.

So just a quick one for me. It sounds like you were surprised by how receptive cap rate environment has been to interest rate changes. Have you seen that kind of same receptiveness to maybe higher escalators particularly on retail transactions?

Yes, we have noticed that it remains challenging in the US to secure uncapped or untethered CPIs, particularly given the current market conditions and the low-margin nature of retail. However, there is now greater openness to higher interest rates or escalators in our leases compared to about a year ago. In Europe, discussions about escalators are much easier, and we can engage in CPI-type adjustments more readily. For instance, the Metro transaction we mentioned includes CPI escalators in the lease. Overall, these adjustments seem to be more feasible in Europe, but we are beginning to see sellers in the US become more amenable to higher escalators than we have typically observed in this sector.

In terms of the fixed escalators on kind of US investments, particularly retail, any kind of brackets on how much they've increased maybe versus last year or even pre-pandemic?

Yes, John. It's going to depend on the type of retail. Higher-yielding options are likely to come with higher elevation and escalators. For investment-grade properties, it remains challenging. They might be open to offering fixed increases every five years, which may not have been the case a year ago. However, it's difficult for me to specify the exact increase in this environment. What I can say is that we are observing increases.

Understandable. That’s it for me. Thank you very much.

Thanks, John.

Thanks Nick. Thank you all for joining us today. We're looking forward to ending 2022 strong and in seeing many of you at the NAREIT conference in two weeks. Good evening.