Realty Income Corp (O) — Q4 2022 Earnings Call Transcript

Thank you all for joining us today for Realty Income's fourth 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-K. I will now turn the call over to our CEO, Sumit Roy.

Thank you, Julie. Welcome, everyone. 2022 was a year of significant growth for our company. I would like to express my gratitude and appreciation to the Realty Income team, who have worked tirelessly to execute on our strategic objectives and all of our investors for their support. The result of our team's collective efforts was reflected in our 2022 results, highlighted by AFFO per share growth of 9.2%, the highest annual growth rate for our company since 2013. Additionally, we closed on approximately $9 billion of high-quality investments in 2022, including $3.9 billion in the fourth quarter, both the annual and fourth quarter investment volume set record highs for the company. Underpinning investment activity, transaction flow remains robust. We sourced $17 billion in the fourth quarter, bringing 2022 sourcing volume to $95 billion. Finally, we ended the year with occupancy of 99%, our highest occupancy rate at the end of a reporting period in over 20 years. At Realty Income, we strive to provide stability and sustainable growth on behalf of our investors. During periods of economic uncertainty like we find ourselves in today, the resilience demonstrated by our business model is important to highlight. Throughout our 28-year history as a public company, our combined total return consisting of AFFO per share growth and dividend payments generated by our operations has not experienced a single year of downside volatility in the form of negative total returns. We believe we are in a very limited company among companies in the S&P 500 who can make that claim. This is a testament to the durability of our underlying cash flows, which is supported by a diversified portfolio of properties under long-term leases with clients that are leaders in their respective industries. We are constantly working to incubate new growth opportunities that offer attractive risk-adjusted returns. Since the start of 2022, we have expanded our portfolio by adding new verticals. In October, we completed our debut transaction in Italy, acquiring seven wholesale clubs operated by Metro AG, an investment-grade pan-European leader in the wholesale club industry. As we discussed in 2019, when we purchased our first property internationally, we are intentional about consolidating the fragmented commercial real estate market in Europe, and Italy represents the third country abroad in which we now have a presence. In December, we closed our $1.7 billion acquisition of Encore Boston Harbor Resort and Casino from Wynn Resorts, which represents our first transaction in the gaming industry. The property is a good example of our strategy to partner with best-in-class operators to acquire high-quality real estate. It was purchased at a discount to estimated replacement cost, is subject to a long triple net lease of 30 years with attractive annual rent escalators and is located on prime real estate with structural barriers to competition. As anticipated in August 2022, Massachusetts partially legalized professional and collegiate sports wagering for the state, unlocking an estimated $850 million of gross annual gaming revenue and further supporting the strategic importance of this asset. In addition, we are pleased to announce a significant investment in what we are calling the consumer medical sector through the acquisition of a 224-property portfolio of dental practices during the fourth quarter. We expect this $520 million transaction to be just the start of additional investments we hope to make in a sector that we estimate has a total addressable market in the U.S. of nearly $1.8 trillion in commercial real estate. We believe the consumer-centric medical industry shares many of the same attributes of the nondiscretionary service-based uses that make up much of our portfolio and have proven resilient throughout our company's long history. These locations offer essential goods and services in and around the major thoroughfares in which our assets are located. The properties leased to clients in the consumer-centric medical industry are extremely fragmented, which creates consolidation opportunities, and we believe we are well-suited to address this demand. We believe this industry will continue to move towards a patient-centric model. The trend towards the outpatient model has been ongoing for decades, but we expect this shift to occur in an accelerated fashion post pandemic, manifesting in several ways that support our investment in the industry. First, the convenience of having care delivered closer to the patient will increase accessibility to the patient and reduce costs for all, including patients, payers, and providers. Second, existing clients of ours like Walgreens and CVS will continue to disrupt the status quo as they gain an increasing share of primary care over time. Third, we believe these industry dynamics will help lower per capita spending on healthcare in the U.S. and improve the quality of outcomes. It is also important to note that the adjacency and fungibility of these assets are a strong fit with our existing footprint from a real estate standpoint. As we underwrote this industry, we conducted a study analyzing over 30,000 variables and found that our portfolio had a 90% similarity with a dataset of assets in this industry, and we look forward to increasing our exposure over time. Moving on, as we announced earlier this week, we have entered into a strategic alliance with Plenty, an emerging leader in vertical farm operations, to support the development of Plenty's indoor vertical farms. As the initial transaction of the alliance, we will fund the development of an indoor vertical farm asset near Richmond, Virginia, located adjacent to an Amazon distribution facility. Plenty's highly automated farming architecture efficiently harnesses scarce natural resources to generate production yields that it believes are up to 350 times greater per acre than conventional farming. We regard Plenty as at the forefront of a structural evolution in crop production. In summary, these distinct new verticals are representative of the growth opportunities we expect to unlock over time to create value for our shareholders. Moving on to our portfolio, in addition to our record occupancy at year-end, we are proud to have delivered a rent recapture rate of 103.8% during the fourth quarter on properties renewed or re-leased, bringing our full year recapture rate to 105.9%. We attribute these results to our proactive asset management efforts, the underlying quality of our real estate, and our rent levels in the portfolio relative to market. Despite our recent accomplishments, we are still working through the impact of the pending bankruptcy on our Cineworld exposure, which is 1.4% of our total portfolio annualized base rent. As a reminder, we own 41 assets, 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. Following the announcement of the Cineworld bankruptcy in September 2022, we have collected 100% of contractual rent in each month from October 2022 through February 2023. As a resolution on the bankruptcy has not yet materialized, we deemed it appropriate to revisit our allowance for bad debts as we assess the collectability of these amounts. As a result of this analysis and in an abundance of caution, in the fourth quarter, we recorded $13.7 million of additional reserves associated with nine Cineworld properties previously under accrual accounting. In total, we now have $35.6 million of cumulative reserves on 31 properties that are on cash basis accounting, representing approximately 70% of our outstanding receivables from Cineworld. As a result of these changes, our unreserved receivable outstanding from Cineworld was $15.6 million at year-end, excluding straight-line rent receivables and including both deferred contractual rent and deferred expense recoveries. The 31 properties on cash basis accounting currently account for approximately $2.6 million of monthly contractual base rent. Based on public information and our proprietary analysis, we continue to believe our portfolio of Cineworld assets generally comprises the stronger performers in the operator's portfolio, and we will provide an update on the outcome of our negotiations when appropriate. Finally, in January, we were pleased to welcome Greg White as Chief Operating Officer. The COO role has been vacant since 2018 when I assumed the role of CEO. Having known Greg for many years, I believe he has the experience, leadership qualities, and business acumen to add immediate value to the management team. Most recently, Greg served as a senior adviser in the Real Estate and Lodging Investment Banking group at UBS Securities. I admire Greg's extensive knowledge of the commercial estate space and his thoughtfulness and integrity will mesh well with our culture at Realty Income. I will now pass the call over to Christie, who will further discuss results from the quarter.

Thank you, Sumit. Moving on to the balance sheet. As publicly disclosed, we've been quite active on the capital markets front. During the fourth quarter, we raised approximately $52 billion of equity proceeds primarily through our ATM program and when including equity sold in the first quarter of 2023, we currently have approximately $850 million of unsettled forward equity available for future issuance. Throughout 2022, we raised over $4.6 billion of gross equity proceeds at a weighted average price of $67.04, almost entirely through our ATM program. We ended the year with net debt to annualized adjusted EBITDA in our targeted range at 5.5 times or 5.3 times giving effect to the annualization. Please note that these ratios do not reflect the outstanding equity forwards I referenced previously. Our capital market activities in the fourth quarter and in January were aimed at striking the right balance between terming out our short-term borrowings while providing us the flexibility to participate in a lower rate environment over the next three years. In addition to the 10-year $750 million senior unsecured bond issuance we priced in October at an effective yield of 3.93%, in January, we executed a dual tranche $1.1 billion senior unsecured bond offering. The offering consisted of $500 million three-year notes callable after one year and $600 million of seven-year notes. In conjunction with the three-year note, we capitalized on an attractive window to swap our interest payments from a fixed to variable rate structure, which we expect will replace a portion of our existing variable rate exposure in the capital stack. After giving effect to the interest rate swap, we effectively locked in a variable rate spread of negative 3.5 basis points to SOFR, which represents estimated savings compared to our credit facility of over 85 basis points. It is important to note that the $500 million of variable rate exposure is expected to be in lieu of variable rate borrowings we would otherwise have outstanding on our revolver or on our commercial paper program. Lastly, in January, we closed on a new $1 billion multicurrency unsecured term loan with an initial tenor of one year and with two 12-month extension options. In conjunction with the closing of the term loan, we entered into a variable to fixed-rate swap resulting in an all-in effective yield of 5%. I would like to take a moment to thank each of our lenders that participated. I would also like to make special mention of Jonathan Pong and Steve Backe for their tireless efforts and leadership in delivering upon our capital market strategies. Moving on to guidance for 2023, we are initiating AFFO per share guidance of $3.93 to $4.03, representing 1.5% growth at the midpoint of the earnings range, and including our current dividend yield, a total operating return profile of circa 6%. The annualization of higher interest rates has moderated our expected growth rate for 2023, but there is much to be optimistic about. The investment pipeline remains active. We continue to source investment opportunities across our target markets at accretive cap rates in the mid-6 to mid-7 range. As a result, we are introducing 2023 investment guidance of greater than $5 billion, and we will, of course, revisit this guidance each quarter as we gain incremental visibility to our transaction pipeline. Finally, as a monthly dividend company, an increasing monthly dividend remains central to our business model. We were pleased to have announced a dividend increase of 2.4% last week, which represents a 3.2% growth rate over the year-ago period. We remain proud to be one of only three REITs in the S&P 500 Dividend Aristocrats Index for having a dividend every year for over 25 consecutive years. With that, I would like to pass the call back to Sumit.

Thank you, Christie. In summary, our 2022 results demonstrated the capabilities of our platform and the competitive advantages afforded to us given our size, scale, and access to capital. Over the long term, we believe stockholders will continue to benefit from the stability of our cash flows as we have proven with our track record of consistently positive total returns. Finally, we believe there is significant runway for further growth in untapped industries and geographies. We look forward to unlocking these opportunities over time. At this time, we can open it up for questions. Operator?

I wanted to ask about the Plenty indoor farm deal. I guess this is a new industry for you guys as well as it seems like a relatively new industry in general. I guess how did you guys get comfortable with underwriting the risk and outlook for indoor farming?

Thanks for the question, Josh. Indoor farming, as part of the revolution that we are seeing in ag tech, is something that we've been looking at for the better part of a year now. Specifically working with Plenty to try to understand their technology and how they're going to play in the ecosystem in terms of delivering crops in a much, much more efficient manner than traditional farming. If you look at ag tech and vertical farming within this space, this is estimated to be a $50 billion industry over the next few years. Plenty has a very established position within this particular vertical. If you look at some of the sponsorship they have, it's with companies like Walgreens, Albertsons, and Driscoll’s. These are some of the largest grocers and providers of end product to grocery stores. Walmart has also invested directly in this company along with others from which they're going to be served the end product. So they have a lot of institutional sponsorship. We've gotten to know the company very well. At the end of the day, it's a $42 million investment, in an ideally located industrial location adjacent to Amazon distribution. We felt very comfortable based on the risk-adjusted return profile across various scenarios that this was going to be a solid real estate investment. Having said that, one phrase used internally, the cherry on top, was the fact that this aligns with our value system, which is about giving more than we take. We genuinely believe that ag tech and vertical farming, specifically, is going to have a big role to play in a world that continues to be resource constrained, yield constrained, and suffering from a deficiency of arable land. For all of those reasons, we got very comfortable with Plenty as an operator, and more importantly, with this particular vertical within ag tech as an industry to pursue.

Could you elaborate a little bit on the returns and the outlays? I know it's a $1 billion pipeline. Is that something you expect to kind of put out the door all this year over the next 2 to 3 years? Are you guys financing the equipment inside the warehouse? Just trying to get more color on the deal.

Sure. We are a real estate company, Josh, first and foremost. So that's all we are going to be investing in. Any equipment and technology, etc., that is Plenty's responsibility. None of the $42 million will be directed towards that. The $1 billion is a number that we hope to invest with this name, which, if we do, would mean this technology has become a success, and more importantly, has established its position as one of the leaders in vertical farming. The investment itself has a potentially much longer horizon, I would say, potentially the next five years. Keep in mind that any subsequent investment beyond the $42 million is at our option. We will approach this partnership from a purely real estate perspective, but one that we believe needs to partner with these types of technologies in order for them to be successful. Ultimately, the real estate needs to work for us on a risk-adjusted return basis. If it does, we are happy to help a company like Plenty continue to establish itself as a frontrunner in this space.

Great. Thank you. Sumit, can you expand a bit on the consumer medical vertical that you talked about in terms of what are the types of service offerings that are most interesting to you right now? What do those properties look like, types of operators, yields, etc.?

Yes. When we're talking about consumer-centric medical, we're discussing aspects that we are already currently exposed to and adding a few more areas. So, those areas include drug stores; however, drugstores of yesterday are not the drugstore of tomorrow. You've probably read in the news that both Walgreens and CVS are investing heavily to continue to capture share of general physician services. This is an incredibly fragmented area of business. They are investing multibillion dollars in their health hubs, minute clinics, and more to provide those services. Other areas gaining momentum include infusion centers, dialysis, eye care, dental care, pediatric care, behavioral facilities, and urgent care; all of which have significantly gained traction, especially post-pandemic, as methods of delivering healthcare to end consumers. The belief here is that the per capita healthcare cost that we experience in the U.S. is essentially twice the average of what an OECD country experiences. Hence, it’s vital to reduce these costs, where convenience, better accessibility, and established relationships can be instrumental. Currently, only 30% of the population has a designated general physician that they can identify; 70% do not. This speaks to the importance of preventive care in minimizing future costs. Anything concept lending itself to this will attract our focus. We have analyzed the actual properties these facilities occupy and found a 90% overlap with locations and properties we currently own in terms of size, layout, etc. There are numerous variables we examined. These assets that support consumer-centric medical are incredibly fragmented, representing a $1.8 trillion market today, expected to grow to $2 trillion by 2027. This is about increasing our total addressable market and effectively employing our core strengths while helping consolidate the market and defining what net lease investing is.

Okay. Sorry about that. And then my second question relates to yields. Thinking about the near term, first and second quarter, I think you mentioned mid-6s to mid-7s. You did 6.1 in the fourth quarter, but should we expect that it moves into that range here in the near term? Or is that a number that you might achieve over the course of the year? Just trying to gauge what you're seeing on the ground today.

Yes, Tony. We indeed released some numbers on January 9, where we shared observations regarding our pipeline, which included transactions under contract and accepted LOIs, approximately worth $1.3 billion at a 7.1% cash cap rate. Clearly, what we are discussing regarding cap rates is manifesting in the pipeline we created until that point. More generally, we have observed about a 100 basis point movement in cap rates—up or down. This was as expected since 14 of the top 20 clients we have see their spreads have widened about 100 basis points over the last eight to nine months. While not necessarily perfectly congruent, it does relate to the changes in cap rates. So you should expect to see those numbers starting to materialize beginning in the first quarter of 2023.

Good afternoon. Sumit, regarding M&A, is that more or less likely in this environment with the opportunities you're finding in other verticals and portfolio discounts like we saw in CIM 71 cap? Or does paying a premium for public peers make sense at this time?

That's a great question, Greg. If you look at the organic market, and you've mentioned CIM and some of the other transactions we've discussed, there are excellent transactions available offering impressive risk-adjusted returns. However, if an M&A opportunity presents itself that offers similar economics, I don’t see that as a mutually exclusive pursuit; both can be avenues to grow the business. Yet this backdrop does present an opportunity cost when contemplating M&A. That said, while conditions may not be conducive to less M&A activity, we have strong feelings about pursuing both paths. We accomplished $9 billion in acquisitions last year, which accounts for about 80% to 90% of our total size. We don't need M&A to sustain our growth, although it can make sense if it aligns.

Have the higher cap rates brought some private equity buyers off the sidelines, or is competition for assets still limited?

They are certainly out there. The debt capital markets continue to be a constraint for them regarding their responsiveness in this environment. Certainty of closure has become paramount over the past six months for potential buyers who, for various reasons, are unwilling to cash in their real estate assets. Companies like us, particularly regarding larger deals that offer closure certainty without relying on the debt capital markets for finance, hold a significant advantage, which has positively affected our recent activities. Private equity will undeniably begin to move closer given the elevated cap rate conditions. However, I still don't believe their cost of capital is as competitive as ours, along with our ability to finalize deals.

As it relates to cap rates, we've heard that the bid spread has compressed faster in the U.S. compared to Europe. Is that consistent with your observations? Do you think that will influence how you deploy capital in '23 across both geographies?

Yes, that's an astute observation, Spenser. If you evaluate the fourth quarter, we didn't execute much volume in Europe—approximately $350 million—yet experienced substantially higher cap rates there. The cause for this was redemption issues funds started facing toward the year's end, which forced them to monetize their portfolios, creating favorable conditions for us. Likewise, in the U.S., the trend has been slowly evolving in this direction towards higher cap rates. I previously mentioned that this rate adjustment has occurred more swiftly amid rising interest rates. The present environment showcases a settling at 6.5% to 7% for various products. Of course, there are still properties trading in the high-5s and even some in the low-5s. In fact, we sold one of our QSR assets with a 4% in front of it regarding cap rates. Therefore, we will not focus on those tail areas but will continue to monitor overall market movements.

There have been headlines regarding a EUR600 million to EUR700 million portfolio being marketed for which a bidder has been cited. Can you share any insights on the portfolio in terms of its general makeup or geography?

I’d be curious to know your sources, Spencer. We prefer not to discuss transactions we do not have under contract. Therefore, we cannot comment on any hypotheses or rumors circulating in the industry.

Sumit, good afternoon. I'm curious about your high-grade philosophy. Again, I noticed in the fourth quarter, your share was below your portfolio average even when you back out the Encore. Previously, you've mentioned acquiring higher-yielding assets while focusing on the best risk-adjusted returns. Yet again, it's another quarter where your share of high-grade properties is far below your portfolio average. Can you update us on how to view this dynamic going forward?

You effectively answered your question, Haendel. Ultimately, this is about finding the best risk-adjusted returns, just as you stated. Whether something is investment grade is simply an output of that underwriting—it’s not our primary measure of focus. Notably, the counterpoint to what you’re observing in Q4 is the CIM transaction, which has an $894 million deal bringing in 48% of rent from investment-grade operators. We expect this number to fluctuate. If you were to exclude high-grade properties from the $3.9 billion we did in Q4, that investment-grade number would be around 40%. Therefore, we are comfortable proceeding with any transaction that aligns with our risk profile.

What about the investment in Italy? Was the investing in the quarter basically the $350 million in Europe you mentioned? What's the relative risk profile, how are you underwriting there versus the rest of Europe or the United States? What's your appetite for investments in Italy?

Italy as a country indeed possesses additional risk. However, just like when we invested in the grocery business amid Brexit, we were meticulous about choosing the industry and operator we partnered with. Metro AG is a well-established, investment-grade entity controlling 26% of the wholesale business in Italy. This isn’t a venture, nor a fly-by-night operation; they are solid, having operated since the 1970s in some locations. Metro combines elements of Costco and Cisco. Their business model is robust, which gives us comfort despite certain Italian market risks. There are various structural advantages that draw us to Italy, but we will certainly be cautious regarding industry partnerships and risk-adjusted returns.

Was the investment $350 million in the quarter? What are the going-in cap rates?

The $350 million was our total investment dedicated to Europe. Metro specifically accounted for about €165 million of this. Most of the other investments were concentrated in the U.K.

Can we quickly touch on tenant health? Obviously, occupancy is 99%. I see that the EBITDAR coverage is up slightly quarter-over-quarter. In the past, you’ve mentioned stress testing tenants and feeling good. What’s the outlook regarding potential recession and tenant health?

That's an excellent question, Ron, especially entering 2023 with uncertainties. Our primary focus right now is on Cineworld and what that resolution will entail. I believe what will transpire with that will become clear within the next few months. We've observed 100% monthly rent collection from Cineworld since October 2022, even during the ongoing bankruptcy discussions. Our overall coverage ratios have continued to improve, primarily due to high-performing existing clients such as Albertsons. New transactions we’ve entered also have strong coverage ratios. Our focus has primarily been on generating cash flow coverages, which have risen to about 2.9x despite some adjustments. Currently, about 4% of our rent falls under our tenant watch list, predominantly driven by theater-related challenges. While we're optimistic, we recognize the potential for volatility with lease expirations, especially in that sector.

How has it been going in the gaming sector since the Encore deal closed? What does your pipeline for additional acquisitions in this sector look like?

We are proud to own this outstanding asset in Boston. Upon our announcement regarding the acquisition of this asset, we experienced a notable increase in social media engagement. This indicates that it was well-received by our audience. We're delighted to partner with Wynn, who are recognized operators. Our goal isn't just a one-time transaction; we intend to grow in this industry. We're focused on finding best-in-class operators and securing iconic assets. We have received several proposals but have opted not to pursue them for various reasons. We aim to be selective, yet we are very interested in growing our presence in this area over time.

There has been a lot of M&A activity in value-based care. Is this the industry you’re referring to as having potential? Would you get the parent's credit on some of these deals?

Absolutely. When discussing Oak Street Health, which CVS recently acquired, should they want to monetize associated real estate, we would certainly seek CVS' credit on these transactions. Walgreens undertook a similar approach, as did Amazon. This is exactly the market segment we are targeting. By classifying this as consumer-centric, we take a real estate perspective and explore future synergies with existing properties. The forward-thinking health companies and operators are embracing this model. Additionally, existing pharmacies are transitioning into health hubs and clinics; this trend is increasing due to rising consumer demand. We aim to foster growth through investments in this area, reinforcing our presence.

Understood. Would there be many ground redevelopment opportunities? Do you have significant redevelopment funding experience?

Yes, we do have a history of redevelopment funding, Wes. Today’s pipeline includes several instances of repositioning our existing assets. We’ve partnered with national entities for these initiatives, achieving impressive recapture rates in our portfolio. When discussing the 90% overlap concerning real estate characteristics with potential consumer-centric medical concepts, this lends itself well to repositioning some of our assets for optimal utilization.

Could you share your views on interest rates and the capital markets? Jonathan and Steve have indeed been busy with several less traditional instruments, including the term loan with multiple extensions and callable unsecured notes. What’s your strategy with these?

Michael, our actions in early January were aimed at ensuring financial flexibility. We initiated a three-year non-call one offering, providing us the flexibility to recapture at par after one year. We also secured a one-year term loan with two 12-month extension options. Our goal was to mitigate risks associated with locking in lower rates early in 2022 during our capital raising efforts while remaining agile for future opportunities.

Does this evolution point to a fundamental change in traditional core retail or industrial assets? Do you think these opportunities instill more confidence in maintaining or exceeding the $5 billion annual acquisition guideline established in previous years?

That’s an insightful inquiry, Michael. We've often reflected on this question. The traditional definition of a net lease company exists, yet we assert that our size and scale are strengths. Over the past four years, we have enjoyed 5% compounded annual growth. The question lingers: what can we do with our core strengths, size, and access to capital? If it seems we're confined by ignorance towards creativity, that would limit our path. However, upon redefining the net lease realm, we’ve discovered ample opportunities. The only real constraint lies in our capacity for creativity. We endeavor to consolidate real estate through a net lease structure. The market is both receptive and eager for this type of innovative investment.

As we think about the delta in the Plenty transaction between the $42 million committed for the Virginia projects and the $1 billion pipeline, do you have any sort of right of first refusal or purchase option for the higher amount?

The best way to express this is regarding future real estate developments specifically targeting this partnership while providing all opportunities from which we may opt to capitalize should the returns align.

Could you provide more information on the dental portfolio acquired in Q4? What made it particularly attractive, and could you share details regarding the credit behind these assets?

Unfortunately, we can't share too many specifics since this was highly negotiated and is a significant entry into the consumer-centric medical field. However, I can tell you it represents an operator who owns both the operation and real estate. The approach allows them to monetize real estate assets while investing in their business operations. Total earnings for the quarter were $4 million. As you’re aware, the overall cap rate for the quarter was shared, but this dental acquisition was a modest part of that.

What benefits do you hope to achieve with the recent appointment of the COO?

Greg is sitting here; he’s been with us about 1.5 months, and he’s already added immense value to discussions. He possesses a bright mind, and I’ve respected him for almost 15 years. He brings a unique perspective, which will be incredibly beneficial as we evolve as an organization. As we expand, we need talents to help crucial growth areas. Equally important are Greg's integrity and mentoring abilities to guide our next group of leaders internally, and he will significantly assist in fast-tracking them into senior leadership positions, which will be instrumental in executing our strategy. Regarding recurring capital expenditures being under 1% of Realty Income's NOI, does it vary between domestic and international properties, and do your new verticals align with this threshold? It’s dependent on the leases we have. For industrial leases, the landlord manages structural and roof responsibilities; thus, associated capex will be higher. Categories can differ based on maintenance or improvements. In the U.K., even on the retail side, we don’t have strictly quad-net assets; thus, we experience more leaks there compared to the U.S. Overall, recurring capex is minor, shared in the AFFO, and we underwrite these expenses into any long-term return profiles of our transactions.

About your watch list dynamics: with increasing non-investment-grade exposures, your watch list appears larger. Although your coverage ratios strengthen, how should we approach credit provisioning given these factors? Looking for guidance on how to determine adequate provisions in light of these economic circumstances.

It’s not an exact science. You’ve pointed out two contrasting data points—strengthening ratios while pursuing more non-investment-grade opportunities. Our focus remains on underwriting business operability and credit dynamics; for example, some retail names might not be investment-grade yet have strong debt coverage exceeding 5x. In this environment, we are adamantly avoiding transactions involving operators lacking sustainable business models, especially with high-interest rates. Last year reflected that we had provisioning aligned with historical trends; in fact, our bad debt expenses fell below what we typically experience due to careful adjustments throughout the year.

Could you provide specifics regarding provisioning levels for guidance, say, around 60 to 75 basis points?

On the tenant front, we didn’t address the watch list, and there have been recent headlines regarding Red Lobster closing some locations. Could you update us on the watch list and particularly Red Lobster?

As previously mentioned, our overall watch list hovers around 4%. With regard to Red Lobster, there were rumors they sought to negotiate rents with landlords, but I can confirm unequivocally that they haven't approached us. Though they closed some locations, none impact our portfolio. The challenges in their operation represent about 1% of our rent. However, I believe they have rectified earlier missteps and should continue to enhance management and inventory strategies, ultimately leading to better performance moving forward.

Thank you, Dave, for hosting us, and thank you, everyone, for your participation. I look forward to seeing you at the upcoming conferences. Take care.