Realty Income Q4 2022 Earnings Call Transcript

Presentation

[Operator]

Good day, and welcome to the Realty Income's Fourth Quarter 2022 Operating Results Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Julie Hasselwander, Senior Manager of Investor Relations at Realty Income. Please go ahead.

[Julie Hasselwander, Senior Manager, Investor Relations at Realty Income]

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 laws. The company's actual future results may differ significantly from the matters discussed in any forward-looking statement. We will disclose in greater detail the factors that may cause such differences in the Company's Form 10-K.

We will be observing a two-question limit during the Q&A portion of the call in order to give everyone the opportunity to participate. If you would like to ask additional questions, you may reenter the queue. I will now turn the call over to our CEO, Sumit.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

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 an 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 saw $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. And during periods of economic uncertainty like we find ourselves in today, the resilience demonstrated by our business model is important to highlight. During 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 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 swim lanes for growth that offer attractive risk-adjusted returns. Since the start of 2022, we have expanded our [Technical Issues] new verticals to our platform. 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 were 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 represent 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 [Technical Issues] 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 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 that 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 [Technical Issues] properties leased to clients in a consumer-centric medical industry is extremely fragmented, which creates consolidation opportunities we believe we are well suited to address. We believe this industry will continue to move toward 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 and will manifest 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. And third, we believe these industry dynamics will help lower the per-capita spend on healthcare in the U.S. and help 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 data set of assets in this industry, and we look forward to increasing our exposure over time.

Moving on, as we announced earlier this week, actually yesterday, we have entered into a strategic alliance with Plenty, an emerging leader in vertical farms 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 at the forefront of a structural evolution in crop production and [Technical Issues] growth plans. 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 released, 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 resolution on the bankruptcy has not yet materialized, we deemed it appropriate to revisit [Technical Issues] we've had on our Cineworld receivables balance as we continue to evaluate 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 on 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 is generally comprised of 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 Whyte as Chief Operating Officer. The COO role has been vacant since 2018 when I assumed the role of CEO, and 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 advisor in the real estate and lodging investment banking group at UBS Securities. I admire Greg's extensive knowledge of the commercial real estate space, and his thoughtfulness and integrity will mesh well with our culture at Realty Income.

I will now pass the call off to Christie who will further discuss results from the quarter.

[Christie Kelly, Executive Vice President, Chief Financial Officer and Treasurer at Realty Income]

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 $2 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 EBITDAre in our targeted range at 5.5 times, or 5.3 times giving effect to the annualization [Technical Issues] please note that these ratios do not reflect the outstanding equity forwards I referenced previously. Our capital markets 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 notes, 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 programs.

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 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 say thank you to each of our lenders that [Technical Issues] I would also like to make special mention of Jonathan Pong and Steve Bakke for their tireless efforts and leadership in delivering upon our capital markets 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%. Though the annualization of higher interest rates has moderated our expected growth rate for 2023, there is much to be optimistic about. The investment pipeline remains active. We continue to source investment opportunities across our target markets at accreted 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 the 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 raised our dividend every year for over 25 consecutive years.

With that, I would like to pass the call back to Sumit.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

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, [Technical Issues] forward to unlocking these opportunities over time.

At this time, we can open it up for questions. Operator?

Questions and Answers

[Operator]

[Operator Instructions]. The first question comes from Josh Dennerlein with Bank of America. Please go ahead.

[Joshua Dennerlein, Analyst at Bank of America Securities]

Yeah. Hey, guys. Thanks for the time. 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. How did you guys get comfortable with underwriting the risks and outlook for indoor farming?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

So, thanks for the question, Josh. Indoor farming, as part of the revolution that we are seeing in agtech, is something that we've been looking at for the better part of a year now and 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 agtech and you look at vertical farming within this space, this is estimated to be a $50 billion industry over the next few years. And Plenty has a very established position within this particular vertical. If you look at some of the sponsorship that 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. And Walmart has also invested directly in this company along with [Technical Issues] from which they are going to be served the end product. So, they have a lot of institutional sponsorship. We've gotten to know the company very well. And at the end of the day, it's a $42 million investment in a very well-located industrial location, it happens to be very adjacent to an Amazon box. And we felt very comfortable, based on the risk-adjusted return profile across various different scenarios, that this was going to be a solid real estate investment. Having said all of that one of the phrases that was used internally, the cherry on the top, was the fact that this aligns with our value system as well, the value of giving more than we take. We genuinely believe that agtech, and vertical farming specifically is going to have a big role to play in a world that continues to be resource-constrained, yield-constrained, water-constrained and continued deficiency of arable land going forward. So, for all of those reasons, we got very comfortable with Plenty as an operator and, more importantly, this particular vertical within agtech as an industry to pursue.

[Joshua Dennerlein, Analyst at Bank of America Securities]

And then, could you maybe elaborate a little bit on, like, the returns and the outlays? I know it's a $1 billion pipeline. Like, is that something you expect to kind of put out the door all this year or the next two, three. And are you guys financing the equipment inside the warehouse? Just trying to get more color on the deal.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

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

[Joshua Dennerlein, Analyst at Bank of America Securities]

Great. Thanks for the time.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Thank you.

[Operator]

Our next question comes from Anthony Paolone with J.P. Morgan. Please go ahead.

[Anthony Paolone, Analyst at J.P. Morgan]

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 boxes look like, types of operators, so forth, yields, maybe?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Yeah. So, when we're talking about consumer-centric medical, we are talking about stuff that we are already currently exposed to and adding a few more areas around the edges. So, what are those areas? Like, we are already exposed to drugstores. But drugstores of yesterday is not the drugstore of tomorrow. What you've probably heard in the press, both Walgreens and CVS are investing very heavily to continue to take share of the physician -- the general physician services. And this is an incredibly fragmented area of the business. And they are investing multibillion dollars in their HealthHUB, MinuteClinics, etc., to [Technical Issues] to be able to provide those services. And so, that will continue to be an area. Infusion centers, dialysis, eye care, dental care, pediatric care, behavioral facilities, urgent care, those are all concepts that have gained tremendous momentum, especially post-pandemic and will continue to gain momentum as a method of delivering healthcare to the end consumer. And the belief here is that the per capita healthcare cost that we in this country experience is essentially two times the average of what an OECD company -- country experiences. And how do we continue to bring that down? And factors like convenience, being closer to the consumer, making sure that there is a relationship that can be established so issues can be addressed on the front end rather than when it becomes an issue later on in life. I mean, today, if you look at the U.S. healthcare, only 30% of the population actually has a general physician that they can identify as their own, 70% don't have one. And this goes back to preventative care as being a precursor to reducing the cost of healthcare. And that is the business model that we have embraced that we believe will be -- in addition to the traditional ways of delivering healthcare, will be a very important step in helping reduce cost. And so, anything that sort of lends, any concept that lends itself to this will be open season for us. And what we have then looked at is to try to analyze the actual boxes that these types of facilities are housed in. And what we found was that there is a 90% -- and I mentioned this in my prepared remarks, there's a 90% overlap with locations and boxes that we have in terms of size, in terms of [Technical Issues] etc., and there are a whole slew of variables that we looked at and these assets that lend themselves to consumer-centric medical. And so, there are a lot of synergies. It is incredibly fragmented. It's a $1.8 trillion market today, expected to grow to $2 trillion by 2027. And it's all about increasing our total addressable market using our core strengths that we bring to the table to help consolidate the market and continue to sort of redefine what net lease investing is. And this is a perfect example. [Technical Issues].

[Anthony Paolone, Analyst at J.P. Morgan]

[Technical Issues]. Okay, am I still here? Did I cut out?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

You had -- if you were saying something post the end of my answer, we missed all of that. So, you're back on.

[Anthony Paolone, Analyst at J.P. Morgan]

Okay. Sorry about that. Thank you for the color, Sumit. And then, just my second question relates to yields and thinking about just near term, like the first and second quarter. I think you mentioned mid-6s to mid-7s. You did 6.1% in the fourth quarter, but just -- should we expect it moves up into that range here in the near term, or is that a number that you might get to over the course of the year? Just trying to think through what you're seeing on the ground today.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Yeah, Tony, we actually put out some numbers on January 9th. We put out a -- I think a pro sup when we were offering the unsecured bonds, where we shared the pipeline with you. And the pipeline included transactions under contract and accepted LOIs, and that was circa $1.3 billion worth of transactions at a 7.1% cash cap rate. So, clearly what we are talking about in terms of finally the cap rates moving is now manifesting itself in the pipeline that we have created -- we had created until that point. And now, stepping back and more generally speaking, we have seen about 100 basis points plus/minus movement in cap rates, which we expected, given that if you look at even 14 of the top 20 clients that we have who have bonds that are trading, you look at what their spreads have done over the last, call it, eight months, nine months, those have gapped at about 100 basis points. So, not that that symmetry is perfectly congruous, but it seems to have been at least in terms of how cap rates have played out. So, you should be expecting to see those numbers being realized starting in the first quarter of 2023.

[Anthony Paolone, Analyst at J.P. Morgan]

Okay. Thank you.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Sure.

[Operator]

Our next question comes from Greg McGinniss with Scotiabank. Please go ahead.

[Greg McGinniss, Analyst at Scotiabank]

Hey, good afternoon. Sumit, regarding M&A, is that more or less likely in this environment with these opportunities you're finding and other verticals and portfolio discounts like we saw on CIM at 7.1% cap, or, I mean, does paying a premium for public peer make sense at this time?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Greg, that's a great question. look, the -- if you look at the organic market, and you've mentioned CIM and some of the other transactions that we've talked about already, there are very good transactions to be had at incredibly good risk-adjusted returns. Having said that, if there's an opportunity on the M&A front where you're able to realize similar economics, I don't see that as being mutually exclusive to be able to pursue both avenues of ultimately what we are chartered to do, which is grow the business. But it does have that backdrop to compete against as an opportunity cost when we are looking at M&A. But I don't see there being less M&A because of the environment we find ourselves in. It's just the question of are we going to have partners who are willing to see the big picture, who are willing to see that being part of a particular pro forma company is better for the outlook than not. I think those are the elements that need to sort of play out on the seller's behalf in order to perpetuate M&A transactions. But, look, we are very happy going down the path that we have -- that we are going down. We did $9 billion of acquisitions last year. I would say that that's probably, if you look at companies in our sector, that takes care of 80%, 90% of what companies are in terms of their total size. So, we don't have to do M&A in order to continue to grow our business [Technical Issues] and it makes sense for us to pursue that. We are not going to shy away from that either.

[Greg McGinniss, Analyst at Scotiabank]

Okay, that's reasonable. And just for a second question here. Have the higher cap rates started to bring some of the private [Phonetic] equity buyers off the sidelines, or is competition for assets still limited?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

They're certainly out there. The debt capital markets continues to be a constraint for them and their ability to react quickly in this market. I think certainty of close over the last six months has taken on a very different focus for potential buyers who, for a variety of reasons, want to monetize their real estate. And somebody like us, especially when it comes to bigger deals that can have that certainty of close, that does not rely on the debt capital markets to finance their deals, I think has a distinct advantage, which, truth be told, has played out in our favor over the last few months. And so, yes, private equity will obviously start to sniff around given the higher cap rate environment. But I still don't think that their cost of capital is as competitive as ours. And our ability to close still, I believe, stands out when potential sellers have to evaluate who to partner with.

[Greg McGinniss, Analyst at Scotiabank]

Great. Thank you.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Thank you.

[Operator]

Our next question comes from Spenser Allaway with Green Street Advisors. Please go ahead.

[Spenser Allaway, Analyst at Green Street Advisors]

Thank you. As it relates to cap rates, we've heard that the bid-ask spread has compressed faster in the U.S. versus Europe. Is that consistent with what you've seen, and do you think that will dictate how you deploy capital in '23 as you look across both geographies?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Yeah, that's a great question, Spenser. It doesn't have a perfect answer. If you look at the fourth quarter, we didn't do a lot of volume in Europe circa $350 million, but they had a substantially higher cap rate [Technical Issues] and the dynamic that played out there was essentially redemption issues that a lot of funds started to face towards the end of the year. And that sort of precipitated monetizing their real estate portfolios to help meet those redemption issues, which obviously created an opportunity for somebody like us who again does not rely on the debt capital markets, is able to do transactions fairly quickly, and that's what resulted in that much higher cap rate, because for the longest time in Europe, things were not moving. And that's the reason why the volume was only [Technical Issues] essentially happened towards the later part of the year and happened very quickly because of the specific dynamics. In the U.S., the trend has been slowly moving in this direction. And again, I think I mentioned this during our third quarter call, much faster than it had traditionally moved when you have [Phonetic] a rising interest rate environment. And that's just because so much of the capital was pulled out of the market that it pushed especially sellers who are inclined to monetize their real estate continuing going down that path, has allowed for the cap rates to move. Having said all of that, I do believe that where we find ourselves today is more of a bottoming out of that continued movement of expanding cap rates. And it's settling in this 6.5%, 7% for some of the products. Of course, there are still products that's trading in the high 5s. There's still some one-off assets that's trading in the low 5s, maybe even in the high 4s. We, in fact, sold one of our QSR assets with a 4% in front of it in terms of cap rates. So, those markets, we will ignore because those are the tail areas of the cap rate environment. But by and large, we've seen this movement in cap rates play out, and it's now starting to [Technical Issues].

[Spenser Allaway, Analyst at Green Street Advisors]

Okay. That was extremely helpful. Thank you. And there have been headlines regarding a EUR600 million to EUR700 million portfolio being marketed for which O has been cited as a bidder. Is there anything you can share on the portfolio in terms of the general makeup or geography of those properties?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Yeah. I wonder what your sources are, Spenser. We really don't want to talk about transactions that we don't have under contract. So, we may or may not be involved in the transaction that you've mentioned. We can't speak to anything which is a hypothesis or just a rumor in the industry. Sorry about that.

[Spenser Allaway, Analyst at Green Street Advisors]

Understood. Thank you.

[Operator]

Our next questioner is Haendel St. Juste with Mizuho. Please go ahead.

[Haendel St. Juste, Analyst at Mizuho]

Hey, Sumit, good morning, or, I guess, good afternoon out there. Just curious on an updated perspective on your I-grade philosophy here, noticed again in the fourth quarter the share was below your portfolio average even when you back out the Encore. In the past, I know you've mentioned you have experience in acquiring higher-yielding assets and you're focused on the best risk-adjusted returns, but yet again, there's some other quarter, where your share of I-grade is far below the portfolio average. So, maybe can you kind of give us some updated thinking on how we should think about that dynamic maybe going forward? Thanks.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

I think you sort of answered the question that you asked, Haendel. Ultimately, this is a game of finding the best risk-adjusted return, just like you said. And the fact that something tends to be investment grade is an output of that underwriting. It's not something that we seek out. And the counter to what you're seeing in the fourth quarter is the CIM transaction, for instance. Here, we have an $894 million transaction with 48% of the rent coming from investment grade. And we were able to get [Technical Issues] healthy cap rate. So, that number is going to continue to move. In fact, if you were to just look at the $3.9 billion we did in the fourth quarter and, like you did, exclude the Wynn transaction, and one of -- a couple of the larger portfolio transactions that we did, that particular investment-grade number would be right up in the high-40s. So, that's going to fluctuate quarter by quarter. And what we need to get comfortable with is, based on the risk that we are assuming and part of which is the credit risk, are we being appropriately compensated. And if the answer comes back yes, based on expected outcomes, then we are very comfortable continuing to pursue those transactions.

[Haendel St. Juste, Analyst at Mizuho]

Thank you. That's helpful. Wanted to ask about Italy for a moment, with the investment in the [Phonetic] quarter basically the $350 million in Europe that you mentioned in one of your earlier remarks and then maybe can you talk a bit about the relative risk profile, how you're underwriting there versus perhaps the rest of Europe or the United States? And what's the, I guess, investment appetite for Italy? Thanks.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Yeah. Look, Italy as a country definitely has more risk. But again, just like when we invested in the grocery business during the midst of Brexit, and we were very particular about the industry and, more importantly, the operator within that industry that we were partnering with, if you look at Metro AG, it's an investment-grade, very profitable, very well-established business, which is pan-European, I believe it's headquartered in Germany, and it controls 26% of the wholesale business in in Italy. They've been established since the early 1970s in some of our locations. And so, this is a business that we feel very comfortable with. Think of Metro as a combination of [Technical Issues] Costco and Cisco. Costco is very much retail-oriented, and Cisco is much more professionally oriented. Both those businesses -- types of businesses is served out of Metro. And that's not going anywhere despite some of the additional country-specific risk that might exist in Italy. There are structural advantages as well that I'm not going to bore you with, which makes Italy a very interesting place to invest. But we are going to be very particular, just like we were in the U.K. and we were in Spain as to who we partner with, what are the concepts that we are going to be exposing ourselves to, and at the end of the day, what does the risk-adjusted return profile look, taking into account some of these risks, in some cases additional risk that one takes going into these new countries. But we feel very good about the investment that we've made with Metro in Italy.

[Haendel St. Juste, Analyst at Mizuho]

And just if I may, the follow-up is, did you -- is it $350 million in the quarter? And ballpark, what are the going-in cap rates or sense of returns? Thanks.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

No, it wasn't all of $350 million. The $350 million was the total investment that we made in Europe. I believe the Metro was [Technical Issues] EUR165 million [Phonetic] was the Metro investment. Most of the other investments were in the U.K.

[Haendel St. Juste, Analyst at Mizuho]

Cap rate?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

You've got the blended cap rate, I believe, in the supplemental. It was 100 basis points north of what we did in the U.S., 7.1% cap rate.

[Haendel St. Juste, Analyst at Mizuho]

Thank you.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Sure.

[Operator]

Our next question comes from Ronald Kamdem with Morgan Stanley. Please go ahead.

[Ronald Kamdem, Analyst at Morgan Stanley]

Can we just touch on tenant health really quickly? obviously, occupancy is 99%. I see the EBITDAre coverage is up slightly quarter over quarter. In the past, you sort of talked about sort of stress testing the tenants feeling pretty good just outside of the movie theaters. Just where is your head at in terms of potential recession and tenant health? Thanks.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

That's a great question, Ron, especially entering into 2023 with so much uncertainty. Look, our biggest focus right now is on Cineworld and how that's going to -- what that resolution is going to look like. I do believe that whatever that outcome is, it's going to play out within the next few months. It's been in bankruptcy now for the better part of four months, and we have been in negotiations with them. And we will leave it at that. Outside of that, if you look at our overall -- and again, this is something we share in the supplemental -- our cash flow coverages, four-wall cash flow coverages, those have continued to trend up, largely a function of some of our existing clients continuing to outperform. Companies like Albertson's, etc., have continued to generate EBITDA growth on a four-wall basis. And therefore, those coverages have continued to improve. Some of the new transactions that we have entered into have very healthy four-wall coverage ratios. And this is again -- it very much ties in with the comment that I think it might have been Haendel who was talking about why we are doing so many non-investment-grade. If you look at it from a real estate perspective and you suddenly have coverages not the four times, five times, in sound businesses but they don't have an investment-grade rating given their size, those are businesses that we will pursue. And so, that's the reason why our four-wall coverage ratio is now close to 2.9 times and it was in the 2.5s about a year ago. So, the health continues to be fairly good. If you look at what is there on our watch list, it's -- about 4% of our rent is on the tenant watch list. And as you can imagine, a lot of it is driven by the theater business. A lot of the theater assets are on our watch list. And in some cases, we also have assets that may not have a credit issue, but there is a location risk associated with what will happen at the end of the lease term given the changing demographics, changing competitive landscape, etc., etc. So, that constitutes our 4%, which is slightly higher than what it was a few quarters ago. And it's largely a function of what's happening in the theater space and what we expect will happen in a continued high-interest rate environment.

[Ronald Kamdem, Analyst at Morgan Stanley]

Great. And then, my second question, just touching on gaming. Obviously, the Encore deal closed. How is that going now that you have the assets, and more importantly, what's the pipeline look like? How are you guys thinking about more -- doing more acquisitions in the gaming space? Thanks.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Yeah. So, we're very proud to own this beautiful asset in Boston. We just had a demonstration internally about our presence on LinkedIn and Twitter. And when we posted the news release around closing on this asset, we had a huge jump in followings. So, clearly, it was appreciated by the audience following Realty Income. And we are very proud to have this partnership with Wynn. They are great operators, and they are very good to sort of continue to understand and learn about this particular industry. And we hope to grow this industry. We didn't do this as a one-off opportunistic transaction. And it's very much in line with looking for the best operators and trying to get assets that are going to be icons for the given operator, but even outside of that. And I think we have checked all of those boxes on the Boston asset. But finding those types of assets will continue to be [Technical Issues] we are focused on. And as you can imagine, we have received several inbounds, but for a variety of reasons, we haven't chosen to pursue them because they don't meet all of the attributes that we are looking for. So, we will be selective in this industry, but we would absolutely love to grow it over time.

[Ronald Kamdem, Analyst at Morgan Stanley]

Great. Thanks so much.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Sure, Ron.

[Operator]

Our next question comes from Wes Golladay with Baird. Please go ahead.

[Wes Golladay, Analyst at Robert W. Baird]

Hey, everyone. I hope everyone is doing well. There's been a lot of M&A activity in the value-based care. So, I was wondering if this is the industry you're referring to where you see all the opportunity. And if so, would you get the parent's credit on some of these deals?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

[Technical Issues] end up looking at Oak Street Health, for instance, that CVS ended up buying, and they want to monetize some of those real estate, then, yeah, by default, we are going to ask for CVS' credit on this $10 billion transaction that they just consummated. Walgreens has done a similar transaction. Amazon just announced that they did a similar transaction. Yes, it is precisely what we are talking about. We are calling it consumer-centric because we are approaching it from a pure real estate perspective and trying to find what are the alternatives of the locations that we have already and how does -- what are the synergies with this new vertical that we are pursuing? It's certainly not looking at what traditional healthcare companies are focused on. That's not our forte, that's not our strength, and that has really no interest to us today. But it is the value-based healthcare that a lot of forward-thinking healthcare companies, operators -- healthcare operators are pursuing. And the derivative of that will be the real estate. It could be our existing pharmacies that are going to be repositioned to HealthHUBs and MinuteClinics. That's already happening. There's continued enhancement. There's continued higher impediments to switching costs that are getting created. Those are all perfect for us. That's embedded value that doesn't get realized day one, but we love to see that happen. And we also want to be intentional about growing the portfolio by doing the types of transactions that we did in the fourth quarter in this particular area because we do believe in it.

[Wes Golladay, Analyst at Robert W. Baird]

Got it. And then, would you have, I guess, a lot of ground-up development opportunities? And then, also sounds like you'd have some redevelopment opportunities. Have you ever done redevelopment funding before, or is that a big part of the business now?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

We've certainly done redevelopment funding, whereas if you look at our pipeline [Technical Issues] today. And some of that is repositioning of our existing assets. And we've done some in-house, we've done a lot of it with partners, national partners that we have. And those have been some of the best recapture rates that we have achieved in our portfolio. So when we talk about this 90% overlap in terms of real estate characteristics of the locations that we currently own and some of these consumer-centric medical concepts, that certainly lends itself to repositioning some of our assets for highest and best use. And we define highest and best use in terms of rent per square foot that we could recapture for a given location that we already own. And so, yes, I'd hope to be able to partner with these operators, show some of our existing vacancies, potential vacancies that are going to come down the pike and reposition these locations to help provide these types of services. So, yes, that is absolutely a value-enhancing proposition that we're going to explore.

[Wes Golladay, Analyst at Robert W. Baird]

Okay. Thanks for the time.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Sure.

[Operator]

Our next question comes from Michael Goldsmith with UBS. Please go ahead.

[Michael Goldsmith, Analyst at UBS Group]

Good afternoon. Thanks a lot for taking my questions. Can you talk about your view on interest rates in the capital markets based on your recent capital raising activities, teams that Jonathan and Steve were busy with, several less traditional items with the term loan, with multiple extensions and the callable unsecured? Just trying to get a sense of what you're trying to achieve based on the laddering with these instruments.

[Jonathan Pong, Senior Vice President, Head of Corporate Finance at Realty Income]

Hey, Michael, it's Jonathan. I would say the activities that we did in January, early January, it's all about financial flexibility. We, if you'll notice, did a three-year non-call one, giving us that flexibility after one year to call at par. We also did a one-year term loan but with two one-year extension options [Technical Issues]. And so what we're trying to avoid, especially since we went long on the curve earlier in 2022 with our debt capital raising efforts, was to lock in rates that at these levels aren't very attractive to us. We would like to think that over the next three years, there will be a more advantageous window for us to tap into the debt capital markets to term these amounts out. And so, it's really about maybe a little bit of barbell given the activity we did earlier in the year, much lower long-term rates, but also terming out the revolver to an extent and creating that flexibility for us to participate in lower rates if they come.

[Michael Goldsmith, Analyst at UBS Group]

Thanks for that, Jonathan. And my second question, we've talked about each of the new verticals in depth, but just wanted to talk about the big picture associated with this. Does this -- is this a function of something that has fundamentally changed with kind of the traditional core retail assets or industrial assets that you have -- are known for? And, I guess, does this -- do these new opportunities provide more confidence in your ability to consistently hit or exceed the $5 billion of acquisitions that you've guided to the last couple of years? Thanks.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

That's a very good question, Michael. It's a question that we've asked ourselves. There is a traditional definition of what a net lease company does. And, yes, we can certainly be mandated and dictated by that, or there was a way for us to step back and say, look, if we look at Realty Income, what is our core strength today? Our size and scale, which people have continued to point to, as impediments to growth, if you look at the last four years, we've grown our business at 5% CAGR annually. And if you look at the business, this question has been asked for the last 10 years. [Technical Issues] we are going to take what has been used by the Street as an impediment and see if we can garner value for us, shareholders, and let's just ask the question, what is it that we can do with the core strength of size, scale, cost of capital that will be difficult for other companies to follow? And if the answer was sorry, you're constrained by your business model, and this is all you should do, and this is all you can do, that would have been the answer. But what we found, once we started to ask the question around redefining this particular space, is that there's plenty for us to do and we are only constrained by our ability to be creative. And ultimately, if we continue to underwrite these verticals and look at it from the perspective of real estate and look at it from the perspective of a net lease, suddenly the answers that start to pop up are very different. And it allows you to do things and allows you to be very creative and create outsized returns for our shareholders that with due respect, a lot of our peers are going to struggle trying to mimic. They just don't have the scale. And so, if we can help consolidate real estate through a net lease structure, that is really the only governing principle that should be constraining us and ultimately be able to show to the shareholders that on a risk-adjusted return, these are as safe, if not, in some cases, safer than investing in traditional retail net lease businesses, then it's a win-win. So, that's how we are thinking about the business, Michael. And you will continue to see us be very creative. But like I've always done and like this team here has always done, we will engage with you to share our thesis. And by the way, I do highly encourage everyone to go to the new deck, the investor deck, where we have laid out our thesis in more detail. And you'll see some numbers around [Technical Issues] and you'll find that this is what, I think, people invest in Realty Income for. And we are just delivering on that promise.

[Michael Goldsmith, Analyst at UBS Group]

Thank you very much for that. Good luck in 2023.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Thank you.

[Operator]

Our next question comes from John Massocca with Ladenburg Thalmann. Please go ahead.

[John Massocca, Analyst at Ladenburg Thalmann]

Good afternoon.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Hello.

[John Massocca, Analyst at Ladenburg Thalmann]

[Indecipherable] the hour mark here. So, I'll take us back to the beginning a little bit. As we think about the delta in the Plenty transaction between the $42 million committed for the Virginia project and the $1 billion headline opportunity, do you have some kind of, like, right of first refusal or purchase option to kind of get to that higher number? Just trying to kind of figure out what's in the remaining amount beyond the $42 million for the actual project that's underway.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

John, the best way to answer that is any real estate development outside of a carve-out for one particular client that I mentioned already, which is a user of their end product, we basically get to take a look at the opportunity. And, and then, if we wish not to pursue it, we don't have to. But we, as their real estate partner, will be given the opportunity to look at any real estate development that they enter into over the next five or six years. There's a time frame associated with that. But ultimately, the goal here is to continue to invest because that would mean that they are becoming a more and more successful operator within vertical farming, and we are their real estate partner going forward. But, yes, so it is a concept of -- the optionality lies with us in terms of how much more we invest.

[John Massocca, Analyst at Ladenburg Thalmann]

Okay, understood. And then, can you provide a little more color on the dental portfolio acquired in 4Q? What made that specific portfolio attractive? And can you provide some color on the credit behind those assets?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

So, it's not rated. It was a situation where you had the operator own both the operations as well as the real estate. And this was a mechanism for them to monetize their real estate and continue to invest in the operations of the business. I think we are very constrained by what it is that we can share. This was a highly negotiated transaction, but it is one that we are very excited about. And this is, again, an advent into this consumer-centric medical real estate in a big way. And we felt like it was large enough for us to sort of engage in and talk about. But we can't be more specific than that. You know what our overall cap rate was for the quarter. And this was a very small component of it, given that it was a $4 million a quarter [Phonetic]. But that's the extent of what we can talk about.

[John Massocca, Analyst at Ladenburg Thalmann]

Okay. That's that. Thank you very much.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Thank you.

[Operator]

Our next question comes from Linda Tsai with Jefferies. Please go ahead.

[Linda Tsai, Analyst at Jefferies Financial Group]

Hi. What are some of the benefits you hope to achieve by filling in the vacant role of the COO?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Greg is sitting right here, and he's already -- he's been with us about a month and a half, and he's already added so much value to all of our discussions. He's a very bright mind. And now, he's going to start blushing, but he's somebody that I've respected. I've known Greg for the last, I guess now it's almost 15 years. And he has a perspective that he brings to the table that is very unique and is going to be incredibly additive to all of us. Look, our business is becoming more and more complicated. We are becoming a bigger and bigger organization. We need talented people to continue to [Technical Issues] that. But the most important thing about Greg, in my mind, is his integrity and his ability to -- and his leadership qualities and his ability to mentor. Those are all qualities that will be put to good use, especially with the next batch of leaders that we are cultivating internally. And he will be a massive help in accelerating them to very senior leadership positions within the Company, which, by the way, this company will need in order to continue to execute its strategy and plan.

[Linda Tsai, Analyst at Jefferies Financial Group]

Thanks for that. And then, just in terms of recurring capex being less than 1% of Realty Income's NOI, does this vary whether the properties are domestic or international? And are your new verticals consistent with this threshold, too?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

It depends on the type of leases that we have. I will tell you that, for example, an industrial lease tends to have structural and roof responsibilities. That's on the landlord. And so, obviously, capex there, not maintenance capex necessarily, but just capex, in general, is going to be higher. Now, some of it will be viewed as maintenance, some of it will be viewed as improving the life of the real estate. So, the categorization of that capex may be different, but it is very much a function of the lease. I would say that in the U.K., there is -- even on the retail side, there is not perfectly what we call quad net asset [Phonetic]. So, we do have a lot more leakage, but a lot more leakage is a relative term to very little leakage here in the U.S. And so, all said and done, it's not a big part of our business. It's something that we share. It's part of the AFFO. And again, all of that is underwritten when we are thinking about the long-term return profile of investments that we make [Technical Issues] obviously take into consideration on the front end before moving forward in transactions.

[Linda Tsai, Analyst at Jefferies Financial Group]

Thank you.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Thank you.

[Operator]

Our next question comes from Tayo Okusanya with Credit Suisse. Please go ahead.

[Tayo Okusanya, Analyst at Credit Suisse Group]

Yes. Good afternoon. Just a quick follow-up on Haendel's question. So, again, doing a little bit more in the non-IT space, your watch list is a little bit bigger. On the flip side, your rent coverages are getting stronger and stronger. How do we think about just kind of credit provisioning on a going-forward basis with all these kind of moving factors and what you kind of look at as kind of adequate provisioning relative to historical levels just kind of given the business backdrop?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Yeah, Tayo, it's not a perfect science. You've put forward two data points that we've shared with you that are polar opposites. How in this backdrop of uncertainty, do we have four-wall coverages that continue to improve, yet we are doing less and less of investment grade, but that goes back to the underwriting. And I already mentioned to you that there are a couple of retail names that are not investment grade, [Technical Issues] but to have coverages north of five times. And again, it's a question of are these businesses that we are comfortable with? With the backdrop of this high-interest rate environment, we are not going to be doing transactions where you're going to have an operator that doesn't have a business model that can sustain what we are going to experience, especially in the near term, because that would not be good. So, I don't think we should over-index to investment grade. I know it makes the conversation so much easier with the outside world, but what we have to rely upon is where can we get return profiles [Technical Issues] superior to alternatives. And I think that's how we are thinking about our business. We clearly have provisioned -- because of this uncertainty, we clearly have provisioned in our guidance a higher bad debt expense. But last year was a phenomenal year for us. We had a similar provisioning that we kept adjusting throughout the year and ended up actually having bad debt expense below what we have traditionally experienced in the business. So, again, we expect the worst. We underwrite to what we expect and allow for the better outcomes to play out. And that's really how we think about our business, Tayo.

[Tayo Okusanya, Analyst at Credit Suisse Group]

Got you. Could you share any specific numbers about the provisioning, like, 60 basis points or 75 basis points as the bogey?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

You mean in terms of what we have in the earnings guidance?

[Tayo Okusanya, Analyst at Credit Suisse Group]

In the guidance. Yeah, in the guidance.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Yeah. I don't think we are going to give that level of guidance because guess what's going to happen, Tayo? Every year, subsequent to this, people are going to want to know that. Just take a look at our history. You've got bad debt expense. It's an income statement line item. You can take a look at the history, and you can see that historically speaking, we've been in this [Technical Issues] code. And last year was better than that. So you can now take that information, overlay what we expect to happen over the next 12 months, and that's how you should create your models.

[Tayo Okusanya, Analyst at Credit Suisse Group]

Fair enough. Thank you.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Sure.

[Operator]

Our next question comes from Josh Dennerlein with Bank of America. Please go ahead.

[Joshua Dennerlein, Analyst at Bank of America Securities]

Yeah. Hey, guys. Just one more. Just on the tenant front. I don't think we touched the watch list. I saw some news on kind of -- Red Lobster has been in the news. I guess it closed a few stores. Any kind of updates on the watch list and maybe just Red Lobster in general?

[Sumit Roy, President and Chief Executive Officer at Realty Income]

You missed it. Somebody else asked us about the watch list. It's right around 4%. you brought up Red Lobster. There were rumors around that Red Lobster was trying to negotiate rents with landlords. I can unequivocally tell you that that is not the case, at least they haven't reached -- approached us. There certainly were assets that they have closed again, none of which impacted our portfolio. And there are some challenges with that operation. It represents about 1% of our rent. But again, I do think that some of the missteps that they had made in the third, fourth quarter of last year have essentially been reversed. They were slow to make pricing adjustments. They have rectified that. And they are managing their inventory much better. And all of those should result in better performance. But I just wanted to make sure that we were talking about facts and not rumors that have percolated in the rumor mill.

[Joshua Dennerlein, Analyst at Bank of America Securities]

Well, thanks a lot, Sumit.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Of course. Thank you.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference over to Sumit Roy for any closing remarks.

[Sumit Roy, President and Chief Executive Officer at Realty Income]

Well. Thank you, Dave, for hosting us. And thank you, everyone, for joining in. I look forward to seeing you guys in the upcoming conferences. Take care.

[Operator]

[Operator Closing Remarks].

Participants

Corporate Executives

• Julie Hasselwander, Senior Manager, Investor Relations
• Sumit Roy, President and Chief Executive Officer
• Christie Kelly, Executive Vice President, Chief Financial Officer and Treasurer
• Jonathan Pong, Senior Vice President, Head of Corporate Finance

Analysts

• Joshua Dennerlein, Bank of America Securities
• Anthony Paolone, J.P. Morgan
• Greg McGinniss, Scotiabank
• Spenser Allaway, Green Street Advisors
• Haendel St. Juste, Mizuho
• Ronald Kamdem, Morgan Stanley
• Wes Golladay, Robert W. Baird
• Michael Goldsmith, UBS Group AG
• John Massocca, Ladenburg Thalmann
• Linda Tsai, Jefferies Financial Group Inc.
• Tayo Okusanya, Credit Suisse Group AG