Realty Income Q1 2022 Earnings Call Transcript

Quartr
Provided by Quartr
May 5, 2022

There are 13 speakers on the call.

Operator

Good afternoon. My name is David, and I'll be your conference operator today. At this time, I'd like to welcome everyone to Realty Income's First Quarter 2022 Operating Results Conference Call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise.

Operator

After the speakers' remarks, there will be a question and answer session. Thank you. Julie Hasselwander, Senior Manager of Investor Relations at Realty Income, you may begin your conference.

Speaker 1

Thank you all for joining us today for Realty Income's Q1 2022 operating results conference call. Call. Discussing our results will be Sumit Roy, President and Chief Executive Officer and Kristie Kelley, 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.

Speaker 1

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, Soumit Roy.

Speaker 2

Thanks, Julie. Welcome everyone. 2022 is off to a strong start and we are continuing to build momentum in our business. I want to express my deep appreciation of our ONE team, whose dedication and collaboration showcase the strength of our team through a timely closing of the Q1, And we remain committed to delivering continued scalability. We continue to make progress on our ESG initiatives in partnerships with our clients.

Speaker 2

In April, we published our 2nd annual sustainability report, which details our commitments, goals and progress on our ESG efforts. I welcome all Realty Income stakeholders to share in our dedication to build sustainable relationships for the benefit of those we serve and encourage everyone listening to read through our 2021 Sustainability Report, important topic on the minds of many stakeholders. And I want to emphasize that we believe our business is by design well positioned to drive value in this climate. Our business model is one that generates significant recurring revenue that flows through to the bottom line. As a triple net lease REIT, our business is insulated from inflation.

Speaker 2

Our clients are responsible for covering taxes, insurance and other operating expenses and as prices increase, many of our clients pass the incremental cost burden on to their consumers or suppliers. The efficiency of our model is reflected in our adjusted EBITDA margin, which is routinely around 94%. Maintaining a conservative capital structure has been a key tenet of our business since our founding and having a well staggered fixed straight debt maturity schedule with no corporate bond maturities until 2024 limits our debt refinancing risk in a rising rate environment. In summary, we believe the appeal of our consistent and predictable stream of cash flows is amplified during periods of volatility like we find ourselves in today. To that end, we look at the last period in which the Federal Reserve increased interest rates from December 2015 through 2018 as a helpful case study.

Speaker 2

During this period, Realty Income's total return outperformed the S and P 500 and the MSCI U. S. REIT Index, both in year 1 of the rate hike cycle and throughout the 3 year duration of that cycle. And during the Great Recession, Realty Income exhibited less operational and financial volatility as compared to many other S and P 500 REITs that carry A credit ratings. From an organic growth standpoint, our asset management team continues to report impressive rent recapture rates.

Speaker 2

This quarter, we recaptured over 106% of rental revenue on expiring leases. Given our lease expiration schedule and proven rent recapture track record, we believe we are well positioned to manage through an inflationary environment. Through 2024, nearly 12% of our portfolio annualized contractual rent is set to expire. And in this regard, inflation could serve as a tailwind to our business as rents and costs to build rise. On the acquisition front, our transaction flow remains strong.

Speaker 2

Certain categories of the market has seen discernible increase in cap rates, cap rates adjust following a lag period of 6 to 12 months. Much of this cap rate expansion can be attributed to levered buyers who have relied upon record low debt pricing to underwrite their returns. Given the current yield environment, we are in a comparatively strong position given our financing strategy. And as such, we would expect our competitive standing to strengthen further. Now turning to the results for the quarter.

Speaker 2

Our size and scale in conjunction with strong relationships we have across the marketplace continue to provide benefits through robust sourcing and acquisition volumes. This quarter, we sourced over $34,000,000,000 of acquisition opportunities and approximately 40% of this amount was sourced from international markets. Our total property level acquisitions for the quarter was approximately $1,600,000,000 Approximately half of our volume in the first quarter was the result of international investments, bringing our total international portfolio to approximately $5,000,000,000 of invested capital. As we announced in February, We signed a definitive agreement to acquire the Encore Boston Harbor Resort and Casino Leads to Wynn Resorts under a 30 year triple net lease with favorable annual rent increases. The $1,700,000,000 transaction includes more than 3,100,000 square feet of high quality real estate Investor Relations, less than 5 miles from downtown Boston.

Speaker 2

Pending regulatory procedures, we continue to anticipate this transaction closing during Q4 of 2022. We believe the market is efficient and while cap rates have stabilized, significant competition remains for the high quality assets results. Our average initial cash cap rate for the quarter was 5.6%, which reflects the quality of locations and clients The weighted average remaining lease term of the assets added to our portfolio during the quarter was 12.3 years And the top industry invested during the quarter was grocery stores. We continue to have access to attractively priced capital, We are pleased with the continued strength of our core operations. We ended the quarter with our portfolio at 98.6 percent occupancy base on property count.

Speaker 2

The weighted average remaining lease term of our overall portfolio is approximately 8.9 years, rent as a result of diligent underwriting and the inherent quality of our real estate, enhanced by the proactive efforts of our experienced asset management team. This quarter, we released 119 leases, recapturing 106.2 percent of expiring rent. And since our public listing in 1994, we have executed 4,260 releases or sales on expiring leases, recapturing over 101% of rent on those re leased contracts. We continue to report our quarterly recapture rates because we believe During the quarter, we sold 34 properties generating net proceeds of approximately 122,000,000 Approximately 84% of the sales volume during the quarter related to former VEREIT properties that were sold vacant. Portfolio delivered healthy same store rent growth, increasing 4.1% during the quarter.

Speaker 2

This was largely attributed to the reversal of $9,400,000 of rental revenue reserves during the quarter liquidity position within the same store pool compared to a reserve of $8,000,000 recognized for the same pool during the year ago period. Excluding the impact of reserves in both periods, we estimate that our same store rent growth would have been approximately 1.2%. At this time, I'll pass it over to Kristie, who will further discuss results from the quarter.

Speaker 3

Thank you, Sumit. During the Q1, our business generated AFFO per share of $0.98 consolidated performance, supported by a strong acquisitions pace and a healthy portfolio. As Sumit mentioned, During the quarter, we recognized a $9,400,000 reversal of non straight line rental revenue reserves. This was primarily driven by the $7,700,000 reversal of our outstanding reserves related to AMC, Reflecting their recovery from the pandemic. Given the performance of our one team, outlook for the future.

Speaker 3

The health of our portfolio and progress achieved during the Q1 of 2022, we reaffirm our previously announced 2022 AFFO per share guidance of $3.84 to $3.97 We ended the quarter with a net debt to annualized adjusted EBITDAR of 5.4 times, in line with our target leverage ratios. And no corporate bond maturities until 2024. As Sumit mentioned in his opening remarks, Our modest debt maturity schedule through the end of next year limits our refinancing risk in a raising rate environment. Our size and scale provide us access to attractively price debt across several markets. For example, in January, we issued £500,000,000 in sterling denominated senior unsecured notes, pricing 5 year 20 year notes at a blended all in yield of 2.28 percent with a weighted average term of 12.5 years.

Speaker 3

During the quarter, we issued over $660,000,000 of equity primarily through our ATM program. And subsequent to the quarter end, we entered into a definitive agreement for the private placement of a £600,000,000 sterling denominated offering of senior unsecured notes, pricing 8 year, 10 year and 15 year notes We greatly appreciate the support from the investors who have participated in our capital markets transactions. Finally, just last week, we announced the recast and upsizing of our credit facility, which now includes a $4,250,000,000 multi currency revolving line of credit with an initial maturity in June 2026 and two 6 month extension options as well as a $1,000,000,000 accordion feature. At our current credit rating, the new revolving line of credit provides a borrowing rate of adjusted SOFR plus 72.5 basis points as compared to our previous credit facility of LIBOR plus 77.5 basis points. In total, 25 lenders participated in our recast and we greatly appreciate the support of our relationship banks, many of whom have supported us for decades and have been integral towards our growth.

Speaker 3

We've been most active during the last 12 months within Corporate Finance and Capital Markets. I'd like to make special mention of Jonathan Pong and his team who have worked tirelessly to bring our corporate financing strategies capital markets execution together with our partners to fruition on behalf of all whom we serve. Realty Income was founded on the principles of income generation and capital preservation. We remain committed to delivering monthly dividends that increase over time as part of a consistently attractive total shareholder return proposition. In March, we celebrated the payment of our 6 20th monthly dividend by virtually ringing the New York Stock Exchange closing bell.

Speaker 3

At Realty Income, the dividend is sacrosanct, and we are proud to be one of only 3 REITs in the S and P 500 Dividend Aristocrats index for having raised our dividend for at least 25 consecutive years. And the value of our business is largely tied to current income as a recurring cash flow vehicle. As a result, the value proposition of Owning Realty Income is comparatively more attractive during inflationary periods versus those whose value is tied to growth in future years. And now, I would like to pass the call back to Sumit.

Speaker 2

Thank you, Christy. Our business continues to perform and we are well positioned to build on our momentum throughout 2022 and beyond. These are interesting times and I remain encouraged by OneTEAM's creativity and work effort. We remain steadfast in our pursuit of providing our stakeholders with attractive risk adjusted returns over the long term. Thank you again to our team and partners for helping us deliver these results and to our stakeholders for their continued support.

Operator

We'll take our first question from Brad Heffern with RBC Capital Markets. Your line is open.

Speaker 4

Hey, everyone.

Speaker 3

Hi, there, Brad.

Speaker 4

Hi, Christy. Sumit, you mentioned in your prepared remarks that you've seen an increase in cap rates in certain categories. Can you give more color there? And are there differences by credit quality or geography?

Speaker 2

Yes, sure. Thanks for the question, Brad. Good question. I think the most obvious difference in cap rates, increasing cap rates we see is in the industrial sector and more so here in the U. S.

Speaker 2

Than in the international markets. I would say if I was You know, ask to quantify what this change is in terms of what we were seeing in the 3rd Q4 of last year to what we started in cap rates on the industrial sector. We are also starting to see on the retail side, Some of the transactions that were struck again in the Q4 of last year with potential levered buyers coming back And certainty of close is taking on paramount importance with regards to the sellers. Retail acquisition opportunities, not so much on the QSR and smaller opportunities, But we are starting to see movement, higher on the retail side, but it is not as dominant and it's not as widespread as we see it on the industrial side.

Speaker 4

Okay. Thank you for that. And then are you seeing any companies that potentially wouldn't have been interested in sale lease

Speaker 2

Yes. I think part of it is that sale leaseback may potentially be better avenue to raise capital and monetize their real estate. But I think part of it is also maturation of the sale leaseback market, especially here in the U. S. We are starting to see first time operators engaging in sale leaseback conversations.

Speaker 2

And a lot of it is not necessarily being generated by activist investors coming into play. A lot of it is organic. This is becoming part of their balance sheet management strategy going forward. And some of these are much larger than what we have typically seen in years past. And when I say that, I mean with $1,000,000,000 in front rather than 1,000,000 And to us, it is a function of the maturation of the sale leaseback market and of course also what Okay.

Speaker 2

Thank you.

Operator

Okay. Sure. Okay. Next, we'll go to Greg McGinnis with Scotiabank. Your line is open.

Speaker 3

Hi, Greg.

Speaker 2

Greg, you may be on mute.

Operator

Yes, Greg, your line is open. I certainly was.

Speaker 5

Thank you so much, Sumit. No problem. So good afternoon. Thanks for taking the question. Christy, the line of credit can now support a pretty significant level of acquisition activity.

Speaker 5

Just curious how you're thinking about maybe debt raises through the balance of the year, Where you anticipate you could raise debt and then thoughts on sterling and euro debt versus dollar debt at this point?

Speaker 3

Yes. Thanks for that, Greg. Yes, we're very excited about the renewal of our 4,250,000,000 credit facility. The team just did a great job and we've got great support from a lineup of banks. In terms of indicative pricing right now, tenure U.

Speaker 3

S. Treasuries. We just received this morning above 4%, call it 4.2%, 4.3 When we look at Sterling, we're probably in 3.7% range and then euro related debt high-two, 28 to 3. And as you know, part of our strategy is to really take advantage of The European execution from a liability perspective. And so as part of our capital strategy, we'd be looking to execute in Sterling and depending on how things pan out throughout the rest of the year, potentially Execute from a euro perspective as well.

Speaker 5

Okay. And then in terms of how you might be thinking about raising debt this year, I mean, do you guys feel a need to get more permanent financing revolver. Are you comfortable just based on where the acquisition guidance is just continuing to load up there?

Speaker 3

I think what you can expect from us, Greg, is to just really be consistent as we executed, for example, in April with the private placement of approximately $800,000,000 We have a delay draw on that, so the pay down is in June. And as you mentioned, we've got our revolver And we also have our commercial paper program that is even further pricing inside the revolver. So we've got a lot of opportunity

Speaker 5

Okay. Thank you very much.

Speaker 1

Thanks, Greg.

Operator

Next we'll go to Nicholas Joseph with Citi. Your line is open.

Speaker 4

Thank you. Maybe just following up on that line of questioning, just with the Just with the Sterling debt issuance and the other capital raising, how hedged are you from a cash flow and asset exposure perspective today?

Speaker 3

Hey, Nick. Yes, so from a hedging perspective, we have hedges in place

Speaker 4

Thanks. And then just on external growth. I mean, just given the 1Q activity and then the casino deal under contract, what were your thoughts on moving acquisition guidance

Speaker 2

Greg, sorry,

Speaker 6

you cut off.

Speaker 2

Could you repeat that last question, please?

Speaker 4

Sure. Can you hear me?

Speaker 2

Yes.

Speaker 4

So the question was just on maintained acquisition guidance, just given the pace of acquisitions year to date and then also with the casino under contract for later in the year. If there are thoughts of moving up acquisition guidance or just Given kind of the uncertainty in the market, how that all blended together in your thinking?

Speaker 2

Yes. So Nick, if you recall, when we first came out with our guidance, this was in late October, I think of last year, which was very unusual for us. And a lot of what was driving that thinking then was making sure that people were able to underwrite What this merger was going to mean for the pro form a company, and we had come out with a number of $5,000,000,000 approximately $5,000,000,000 We haven't changed that. And like you've said, We've obviously made the announcement subsequent to that initial guidance of a $1,700,000,000 transaction. And what I can share with you, Nick, is not all of that $1,700,000,000 was contemplated when we had first come out with the $5,000,000,000 In fact, we weren't even sure we had a deal at that time.

Speaker 2

So could that $5,000,000,000 go up? Yes. But what keeps us a little bit on the sidelines is this continued volatility that we are seeing on the capital market side. And from a pure sourcing perspective, as you can see from the numbers that we've posted, from The next 4 to 5 month pipeline perspective, I can continue to share with you that the momentum is share. It is incredibly positive.

Speaker 2

And what sort of keeps us sort of hedging is what's going to happen in the last 4 to 5 months if this continued volatility remains. We are very comfortable with the $5,000,000,000 number and it's actually We say above $5,000,000,000 And I think we can also go so far as to say that Not all of that $1,700,000,000 which we expect to close in the Q4 was contemplated when we came out with the numbers that we did.

Speaker 4

Thank you. Sure.

Speaker 2

Thanks, Nick.

Speaker 3

Nick, I just wanted to follow-up too to make sure that I captured the breadth of your question. I also wanted to just share that as we've talked about that we use foreign debt to And probably the only other thing you'd be interested in is we also have FX forwards in place to hedge some of

Speaker 2

our foreign earnings.

Operator

Okay. Next, we'll go to Michael Goldsmith with UBS.

Speaker 7

Good afternoon. Thanks a lot for taking the question. Can you give us an update on the VEREIT merger and how the G and A synergies are trending so far.

Speaker 2

Sure. I'll start off and then Christy, if you wouldn't mind just addressing The run rate on the synergies. With regards to the integration itself, I think it has gone According to plan, I would even go so far as to say it's ahead of plan. The 2 companies are integrated from an organizational perspective. And we are clearly seeing that on the acquisition front, on the asset management front, on the property management front, etcetera.

Speaker 2

So, I think organizationally, we are where we were hoping to be. In terms of synergies, I'll let Christy take that question.

Speaker 3

Thanks, Sumit. So we had shared during the transaction that we were focused on executing $45,000,000 to $55,000,000 in synergies. And From the perspective of where we are right now, we're tracking towards the higher end of that range, and well ahead of plan.

Speaker 7

That's helpful. And as a follow-up, more focused on Europe, given what's transpiring there. Could you provide an update on the health of the investment landscape in Europe broadly? And then maybe touch on some of the specific regions? And then within that European portfolio is more concentrated in certain retailers.

Speaker 7

So how do you overtime, how do you look to diversify that, to kind of spread out the exposure? Thank you.

Speaker 2

Sure, Michael. Very good questions. Look, I think by design, we had chosen to enter into Western Europe And we by design chose the UK primarily because of the ease of chosen to continue to work with some very large operators and that investment pipeline has continued to be a major source of our growth of what is today a $5,000,000,000 portfolio. The good news here is the operators that we are partnering with, they are very, very large. And so there is a tremendous amount of runway for us How are we impacted?

Speaker 2

How are our operators impacted? What I can share with you is, as of right now, Today, none of them have operations in Russia, Ukraine or any of the adjacent countries that exposure to Russia is actually Kushtard that has about 36 assets, which is less than 1% of their overall footprint, global footprint, that is based in Russia. And outside of that, none of our operators today have operations in either of those impacted countries. So we have a tremendous amount of pipeline. We have a fair amount of runway to not only continue to grow with the operators that we've established, but also as we branch out into new countries with other dominant operators in those countries.

Speaker 2

And some of which, as you can tell, Carrefour was a brand new name for us, and we did the sale lease back in Spain. We have continued to grow that name and as we continue to add more and more countries and even within countries as we get more comfortable with the landscape and operators, You'll start to see a few other very large names get added to our client registry. So, so far so good.

Operator

Okay. All right. We'll go to our next question, Haendel St. Juste with Mizuho. Your line is open.

Speaker 8

Hey, I guess it's good afternoon out there as well.

Speaker 3

Hi there, Haendel.

Speaker 8

Hey there. So you guys sold $122,000,000 in the Q1. You said mostly REIT assets. I guess I'm curious how much more is there left to sell in that class that you've identified? And I guess why do you have so many vacant properties there, please.

Speaker 8

Thanks.

Speaker 2

Yes. There's about so I'll answer your last question first, Haendel. There is about 100 and Which is clearly why we have 98.6 percent occupancy. Look for us it is This quarter happened to be one where of all the assets sold, about 97%, 98%, I believe it was $118,000,000 $119,000,000 of the $122,000,000 were vacant asset sales. And even that number was largely dominated by 2 industrial assets that we sold vacant, where we were able to strike very good total return profiles.

Speaker 2

This is going to continue to ebb and flow. There'll be quarters where we have some occupied assets that we have opportunistically decided to sell and clearly selling vacant assets is very much part and parcel of our business. And when we do sell vacant assets, We give you a total return profile on what is the unlevered return that we were able to achieve, which this Q1 was north of 9% on an unlevered basis. So these are assets that we may have held for 10, 12, 15 years generated a fair amount of cash flow and even when sold vacant, especially in inflationary environments, It allows us to create and capture the kind of returns that we are posting. But the point I want to make And I want to leave with you, Haendel, is selling vacant assets is absolutely part of our business.

Speaker 2

We go through an Asset Management Analysis, where we try to figure out what is the most economic what is the most positive outcome in terms of the economics of selling the asset, releasing the asset, repositioning the asset or entering into negotiation with the existing clients. And once we sort of go through that, We make the determination to go down one of these paths. And that's what drives our thinking in terms of how we decide whether to sell vacant assets or occupied assets, and that will continue to be the mantra that dictates asset management strategy going forward.

Speaker 8

Got it. Got it. That's helpful. Maybe some comments on thinking on businesses overall. I understand you're not in a position of having to sell assets, but just curious if you're maybe thinking

Speaker 2

So, Haendel, do you think what we are experiencing today is going to continue on? Because, yes, If what we have experienced in the market more recently sort of creates this disconnect between private market valuation and public market valuations and obviously selling assets becomes very much part and parcel of our strategy. Truth be told, handle, we've never outside of those very small pockets of time, I. E. When the pandemic first started, where we had a few weeks where there was a dislocation.

Speaker 2

For a sustained period, we've never encountered a scenario where asset prices were being valued in the private market higher than what our public market valuation indicated. But if that were to play out, hypothetically speaking, we would not be averse to raising capital if needed through asset sales. This is this again, I think will accrue to our benefit given the quality of assets that we have been able to assemble, especially over the last 10 years and more specifically over the last 3 to 4 years. So that continues to remain a strategy, macro environment where things are incredibly uncertain and I hope that that doesn't play out that way. But look, it's absolutely a theoretical strategy that we can lean on if needed.

Speaker 8

Got it. Got it. Can I one more on the guidance maybe for Christy? You reversed that's the $10,000,000 of movie theater related reserves. I'm curious what's left in that opportunity bucket here today and what's contemplated in the guide.

Speaker 8

And maybe a question on the lower end of guidance. Run rate FFO was closer $0.95 You didn't raise the lower end. Maybe help us square that a bit. Thanks.

Speaker 3

Yes. I think certainly Haendel. I mean in terms of the overall reserves that we have remaining from the COVID time period. It's approximately 30,000,000 And the majority of those deferral arrangements are going to be in effect as of July. And so in accordance with our guidelines and the like, we will be ensuring over the next 6 months towards the end of the year that we're collecting in accordance with our deferral arrangements.

Speaker 3

And so as it relates to guidance, we

Operator

Okay. We'll move to our next question, Caitlin Burrows with Goldman Sachs. Your line is open.

Speaker 9

Yes, great. Maybe on the tenant side, Sumit, earlier you referenced it briefly, but obviously you have a lot of individual tenants. What's your impression on how they're doing? To what extent they can pass along impacts to their customers and how that ultimately impacts their ability to pay rent.

Speaker 2

Yes. Look, it is certainly a story that is playing out very differently for those that are well capitalized businesses versus Those that tend to be smaller operators in this high inflationary environment. We had Neil's team, the research team do an analysis on our top 150 clients And they represent about 85% of our rent and we were like very focused on what is going to happen to their balance sheet, their ability to pay In the event that interest rates were to rise 300 basis points from where it is currently and this is a big and, they didn't have the ability to pass through any of those increased costs that they were bearing on to their customers, which is a highly unlikely scenario, but we were trying to figure out what would happen So we feel like, again, by design, we've created a client registry that's predominantly made up of very well capitalized operators. But those one off operators, and Caitlin, you're right, we have a 1,000 different clients. So we certainly have a few one off operators that tend to be smaller operators.

Speaker 2

It is going to be more difficult for them to be able to absorb this and their inability to pass through their costs. But we've had a few general merchandising stores. We've had a few folks who are going to who have actually talked about increasing EBIT margins because of their ability to pass through And predominantly, our client registry is made up of those types of folks. So Yes. Hypothetically, Caitlin, the smaller operators will suffer in this environment and may not make it, but thankfully, we don't have too much exposure to that and it is very small in terms of percentage of our overall rent.

Speaker 9

Great. Thanks. And then maybe just as a follow-up to an earlier question regarding that $45,000,000 to $55,000,000 of VEREIT related G and A synergies. Christie, could you just clarify to what extent Realty Income's already at a good run rate or how much further there is to go When you think you'll get there? Just trying to think of the cadence and timing there.

Speaker 3

Yes. I think, Caitlin, We're already over the midpoint of our guidance for the 1st year of execution. And to that point, we probably have 10% to 15% more to go. There's essentially some lag associated with timing

Speaker 1

Thanks, Caitlin.

Operator

Next, we'll go to Ronald Kamdin with Morgan Stanley. Your line is open.

Speaker 10

I think you've mentioned in the opening comments still on track. Just can you remind us what else sort of needs to be done before That's done and dusted. And the follow-up is just, have you sort of gotten received more interest in sort of the gaming side? And is that an opportunity? Thanks.

Speaker 2

Hi, Ron. Yes. So So going through that process, we've submitted our application. It is being reviewed by the Massachusetts Gaming Group. And we are very hopeful that by Q4, we will be in a position to close this transaction, But that really is the one outstanding element to be able to close this transaction.

Speaker 2

But so far so good. Everything that we are hearing, Everything that we received in terms of MGC's response to our initial application has been quite positive. So We feel pretty good about that. In terms of the industry itself, no surprise. We are getting a lot of inbounds from potential sale leaseback opportunities and the team is reviewing them one at a time.

Speaker 2

But our thesis around this particular space remains the same. We want to partner with the best in class operators and find assets that are truly one of a kind, just like we did with the Boston asset. And if at a very high level those criteria are met,

Speaker 10

Great. And if I could just sneak in one more. Just earlier in the call, you made some comments about sort of the top 150 tenths in the portfolio and 85% of rents. And when I think about aspirations of doing these larger sale leaseback opportunities. Just you take a step back, how many of those clients potentially Do you think our would be interested this would be the right solution for them versus, it sort of have to be new relationships, new tenants for sort of these larger sale leaseback deals in the future.

Speaker 10

Thank you.

Speaker 2

Sure. So Ron, I mean, you've seen us grow our existing relationships to areas where they start to dominate shareholder registry. So for instance, I'll give you a perfect example. We did the 1st sale leaseback for Dollar General. This was I believe in 2015, 2016 timeframe and it was maybe $130,000,000 $140,000,000 sale leaseback.

Speaker 2

With Dollar General through multiple sale leasebacks. It's a similar story with 711. A lot of these part of these clients that you see in our top 20 have grown over multiple years Then we also have the ability to do first time sale leasebacks in a large way with clients like Wynn. These are asset classes that tend to be very large. But again, given that we are about a $57,000,000,000 $58,000,000,000 company today, It is going to register as a 3.5% client.

Speaker 2

And clearly, we have said this very openly We would love to continue to partner with them. And so, this is a function of Being able to do first time sale leasebacks in a big way and now that we are of the size that we are, Our ability to absorb those and when I say big, I mean $1,000,000,000 sale leaseback, even multiple $1,000,000,000 sale leasebacks. That has grown

Speaker 10

Helpful. Thank you.

Operator

Sure. Next, we'll go to Joshua Dennerlein with Bank of America. Your line is open.

Speaker 7

Yes. Hey, everyone. Hi, Jeff.

Speaker 6

Hi. Smith, just wanted to follow-up on your comment that cap rates tend to lag interest rate moves by 6 months. So I guess, why not maybe slow down acquisitions a bit And kind of wait maybe towards the back half of the year to kind

Speaker 11

of get that better cap rate.

Speaker 2

Yes. Hi, Josh. I wish our business was a spigot where you could switch it off and turn it back on at a moment's notice. Unfortunately, our business doesn't work quite like that. When you think about how we source opportunities and How we create a pipeline of opportunities and what is the timing that it takes from making a decision to Pursuing a particular transaction and then closing it, it could take anywhere between 4 to 6 months from start to finish.

Speaker 2

So unless you have a crystal ball, it is very, very difficult to be able to sort of Do exactly what you suggested, which would have been perfect if we could. The other thing I would tell you is There's a lag even in our cost of capital. When you have volatile situations like this, but you're seeing opportunities that Seem very well priced on a pure real estate underwriting in terms of placement costs, in terms of price per pound and you think about The leases that we are able to capture with the clients that are engaging in these types of transactions, You obviously build into your underwriting a particular buffer, and hopefully we've been conservative enough capital while continuing to enhance the our basic share growth as well as our client registry with new relationships. So it's very difficult. Now if we had a different mindset over the next 6 to 9 months, which said, Hey, the world's going to fall apart.

Speaker 2

We absolutely will pull in our horns just like we did in that very first quarter right after the it was actually the Q2 of 2020 when the pandemic hit, went silent for a bit just because people were very unsure of how things are going to play out. But that I've already shared with you is not the case. Sourcing remains very healthy and we feel like even with the appropriate flexing of our own cost of capital, We are able to grow our business, in a manner that is very much aligned with our acquisition strategy. But Josh, I'll be very honest, if Our views change. We will stop continuing to build the pipeline, but that is not the case right now.

Speaker 6

Okay. That's fair. And then maybe another follow-up about expanding into other countries in Europe.

Speaker 2

What is it that

Speaker 6

get you comfortable to expand outside the UK and Spain?

Speaker 2

The right opportunities. There are already a set of countries that we have pre approved, so to speak, internally and have shared with our Board that there are countries that we would like to be able to grow in the event the right opportunities come along. We have identified the businesses that we would like to do business with. We've identified the clients. We've identified the fact that these are businesses that will

Speaker 6

Great. Thanks guys.

Speaker 11

Thank you, Josh.

Operator

Next, we'll go to John Massocca with Ladenburg Thalmann.

Speaker 11

So I think historically you've kind of looked at long term same store growth. I understand you have a target for guidance this year, but long term same store growth is being right around 1%. Some of the things you're seeing in terms of maybe rent on renewals and Just the effects of increasing prices across the real estate world in general, increase that outlook? I mean, is that enough to move the needle? Or is it just Obviously, going to primarily be the rent bumps you have in place, but I mean, can that be big enough given the lease expiration schedule to move that up maybe noticeably.

Speaker 2

Well, John, that's what makes us different, right? I mean, if you look at our wall visavis our peers, we are at right around 8.5 years. And if you look at our lease maturity schedule, And I think I said this during my prepared remarks that 12% of our leases are going to renew over the next two and a half years. And so it does. If we can keep this momentum, I don't know if it will be 106%, But the other thing I would say about that 106% is it's effectively net increases.

Speaker 2

And so if we can keep it in that zip code, that will become a major growth driver for our business And it will become an internal growth driver of our business, especially if we continue down this highly inflationary environment. The other good news is, if you think about our international expansion, a lot of those leases tend to be CPI adjusted leases. And they don't tend to have this color, a ceiling and a floor that we experience here, but it's a relative comment. I would say the vast majority of CPI leases that we have here in the U. S.

Speaker 2

Tend to have a caller. And I would say maybe 1 third to even 40 percent of the leases In the international markets tend to be basically do not have a collar around it and they are very much tied to CPI growth. And so I think all of that will start to percolate through our portfolio and will help us drive more internal growth than what we have historically experienced in our business. And we think of this as an opportunity and we've been talking about asset management now for about 5 years, 6 years in anticipation of what we are now starting to experience as a company. And so, look, we think we are very positively set up to take advantage of this situation and it then helps us alleviate some of the pressure of just growing through external measures, which of course is also something that the team is doing very well.

Speaker 11

And then on the external growth side of things, obviously, you're a bigger company, so you would expect this to grow, but the development pipeline seems Kind of keep taking legs up. I mean, is there something specific driving that?

Speaker 2

Yes. It's by design, John. We want development to continue to tick up because we do get more spread during development. And this allows us to continue to be the one stop solution, that our clients are looking for. And just to be super clear, we are talking about build to suit on 99% of our development.

Speaker 2

So I mean This is Are you

Speaker 11

monitored by client demand or is that something just you haven't been exploiting that market maybe 3 years ago, the same way you are today.

Speaker 2

John, they are built to suit. So by definition, They're being driven by our clients coming to us or coming to a developer and saying, we would like to have you develop here in this particular location because we would like to enter into a long term lease. And we have either relationships directly with our clients We then ask us to work with a developer or with some developers who have asked us to become their capital source as a permanent takeout. And that is what's allowing us to continue to enhance our development pipeline. So this is absolutely being driven

Speaker 11

Okay. That's it for me. Thank you very much.

Speaker 2

Thanks, John.

Operator

Next, we'll go to Linda Sai with Jefferies. Your line is now open.

Speaker 3

Yes. Hi.

Speaker 12

Hello. In terms of driving higher internal growth that you just mentioned, is there a range you'd like to target or move towards over time?

Speaker 2

10%. Linda, not trying to be flippant, but look, our intention to try to drive that up. Some of it will naturally come with the expansion in asset types. There are certain asset types that lend themselves to higher organic growth. That was part of the attraction that we had with investing in industrial assets And we saw that.

Speaker 2

And some of these other asset types, just Like I said, do have a higher profile than the 1% that we've traditionally been able to get in the space that we had targeted drill with more development, where we can create more bespoke leases. If we can get that 1% to 1.5% to 2%, That would be a major uplift and a source of internal growth, but that's not going to happen overnight. It's going to take us time and it's going to take intentionality, which we certainly have.

Speaker 12

Thanks. And then just to follow-up, any general update on the theater business? To the extent you've seen more recovery, would you look to sell some of these assets?

Speaker 2

We are not quite there, where we would want to sell our theater portfolio, Linda. In fact, expectations have been, all trend lines have indicated that the theater business is getting back to a strong footing despite all of the noise that we hear about the theater business and PBOD and all of that. In fact, I was looking at some numbers in the Q1 of 2022. We are back to about 75% 2 to 3 months. We are very hopeful that that will translate to more attendance.

Speaker 2

And the good news is couple of these largest large operators like Regal and AMC are cash flowing positive on the assets that we own. So, I think all of that leads us to believe that business. This industry as we had hoped and our hypothesis was is sort of on the mend. Having said all of that, We also did a fair amount of downside scenario analysis where we looked at some of these locations, and we feel like we have the ability, the capital, the relationships to reposition these assets in the event that the business doesn't play out. I think the wrong economic decision today would be to sell some of these assets at what I would consider to be fire sale prices.

Speaker 2

And again, just to remind everyone, 82% of our portfolio is in the top two quartiles of performance for both these operators. So we feel very good about the theater business, but more specifically about the portfolio that we own. And so the decision to sell though a theoretical one and has been considered is one that we are not in a position to execute on given some of what I just shared.

Speaker 1

Thank you.

Speaker 2

Thank you, Linda.

Operator

Conference call. I'll now turn the call over to Sumit Roy for any concluding remarks.

Speaker 2

Thank you all for joining us and we look forward to speaking at the upcoming NAREIT conference. Thank you all. Bye bye.

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Earnings Conference Call
Realty Income Q1 2022
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