Q1 2021 Realty Income Corp Earnings Call
Good day and thank you for standing by welcome to the Realty income first quarter 2021 operating results conference call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question. During the session you will need to press star one on your telephone.
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I would go on to hand, the conference over to your Speaker today, Julie has a wonder investor relations at Realty income. Thank you. Please go ahead.
Thank you all for joining us today for Realty income.
<unk> operating results conference call discussing our results will be Sumit, Roy President and Chief Executive Officer.
Christie Kelly Executive Vice President Chief Financial Officer.
During this conference call.
Certain statements that may be considered forward looking statements under federal Securities law, the company's actual future results may differ significantly from the matters discussed in any forward looking statements, we will disclose indeed greater detail the factors that cause such differences in the company's form 10-Q, we.
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 re enter the queue I will now turn the call over to our CEO Sumit Roy.
Thanks, Julie and welcome everyone.
The continued strength of our business is made possible by the incredible partnerships, we have with all stakeholders.
I would like to express my gratitude and appreciation to our Realty income team.
Continues to effectively execute our strategic objectives, while enduring a sustained remote work environment.
As we've announced last week, we are excited to have reached a definitive merger agreement with varied which will further distance ourselves as a leader in the net lease industry and create a company with a combined enterprise value of approximately $50 billion.
We believe shareholders of both companies will enjoy meaningful value creation through immediate earnings accretion and expanded platform with enhanced size scale and diversification driving further growth opportunities and strategic and financing synergies, which are enhanced by realty income a rated balance sheet on <unk>.
Sales to well priced capital.
We are very excited about this strategic transaction and look forward to continuing to drive future growth together as a combined enterprise.
However, today, we will focus on what was a very successful first quarter per realty income.
Our first quarter results illustrate our ability to grow through a variety of swim lanes reported to us by our size and scale by completing over 1 billion in acquisitions.
Notably in this quarter, we invested approximately $403 million in high quality real estate in the U K highlighting the continued strength of our international platform on bringing our total investment in the UK to over $2 billion since the first international acquisitions, we closed in 2019.
Domestically, we invested $625 million in that state, including our first ever acquisition in Hawaii, becoming the first and only REIT to own property in all U S States.
Our accomplishments during the quarter continued to demonstrate the momentum in our business and highlight our ability to leverage our size and scale to drive our business forward in pursuit of sustainable growth.
On the subject of sustainable growth on <unk>.
Team continues to make tremendous progress to our ESG initiatives.
As ESG considerations continue to permeate throughout our organization at every level.
In April we published our inaugural sustainability.
Board, which detailed the company's commitments goals and progress to date with regard to environmental social and government initiatives.
I invite all realty income stakeholders to share in our dedication to embrace a changing work for the benefit of all those we serve and I encourage everyone listening to read our 2020 sustainability report found on our corporate responsibility page of our website.
Additionally, we are excited to share an updated investor presentation with the marketplace.
On the homepage of our website you can find a new deck, which highlights our fundamental business philosophies key competitive advantages and plan for future growth.
Turning to results for the quarter.
Our global investment pipeline remains a significant driver of growth for our business.
Our business is simple we seek to acquire high quality real estate leased to leading operators and economically resilient industries in pursuit of stable and increasing cash flow generation.
Our confidence in continuing to grow our platform stems from the quality of Paul real estate portfolio, which is designed for resiliency through a variety of economic environments.
Key to mitigating economic risks, we believe in portfolio diversification by geography client industry and property type.
We continue to grow our real estate portfolio.
The first quarter of 2021, we invested over $1 billion in high quality real estate and we remain very comfortable with our 2021 acquisition guidance of over $3 billion to $5 billion.
On a total revenue basis, approximately 39% of total acquisitions during the quarter on leads to investment grade rated clients, which brings our total investment grade client exposure for the portfolio to approximately 50%.
On aligning with our ethos the weighted average remaining lease term with the assets added to our portfolio. During the quarter was 12 six years and at the end of the quarter. The weighted average lease term of our total portfolio was eight nine years.
As of quarter end, our real estate portfolio includes over 600 clients, who operate in 56 different industries.
Approximately 84% of rental revenue comes from our traditional retail properties, while industrial properties generated about 11% of rental revenue.
With regard to our retail business, we seek to invest in industries with a service non discretionary <unk> low price point component to their business as we believe these characteristics make board economically resilient operations that can more effectively compete with e-commerce.
As such all of our acquisitions during the quarter the largest industry represented was grocery stores.
Walgreens remains our largest client at five 5% of rental revenue and convenient stores remain our largest industry at 12% of rental revenue.
Our investment philosophy, primarily focuses on acquiring freestanding single unit commercial properties leased to best in class clients on the long term net lease agreements typically in excess of 10 years.
We believe the market is efficient as such you've seen the competitive environment for high quality assets leased to strong strong operators cash.
Cap rates as you all know reflect an aggregation of many factors, including but not limited to fundamental real estate economics lease term credit of the client or their sponsor rent relative to the market average rent coverage by the operator and alternative use of the real estate.
Accordingly, the quality of our acquisitions is reflected in our average initial cash cap rate during the first quarter of five 3%.
Our size and scale allow us to be highly selective in pursuing investment opportunities that fit our stringent criteria.
This quarter, we sourced nearly $20 billion of transaction opportunities ultimately investing an approximately five percentage of the prospects sourced and reviewed.
Additionally, our cost of capital allows us to invest accretively, even when pursuing the highest quality assets.
During the first quarter on investment spreads relative to our weighted average cost of capital were 115 basis points.
The quality of the assets, we acquired close to the entire lifecycle of our portfolio.
Wowing us to favorably recapture rent on expiring leases and maintain a healthy level of occupancy.
During the quarter, we re leased 54 units recapturing 103, 5% of expiring rent.
Since our listing in 1994, we have executed over 3600 releases or sales on expiring leases recapturing over 100% of rent on those re leased contracts.
And occupancy at quarter end was 98%.
Our size and scale afford us the ability to execute large scale sale leaseback transactions, which are often sourced through existing partnerships with best in class clients, but also serve as an attractive way to establish new relationships with <unk>.
Transaction, we closed in Hawaii is an excellent example of the sale leaseback opportunities we can execute.
In this instance, we partnered with par petroleum to acquire 22, well located convenience stores of approximately $116 million.
All 22 properties fall under one Triple net master lease agreement with an initial 15 year lease term and all assets are located in main and main locations primarily on the island of Oahu.
This quarter about 24% Paul acquisitions, we close were executed a sale leaseback transactions.
The merger between Realty income and Barry will enhance our ability to execute large scale leaseback transactions through expanded capacity to buy in bulk which improve our competitive positioning when competing for portfolio of sale leaseback transactions in the fragmented net lease industry.
As we have previously articulated the ability to buy it wholesale prices and at a discount to the one off market is a competitive advantage.
We are often one of only a handful of buyers for large scale portfolio transactions, particularly those that would otherwise create untenable client or industry concentration issues for our competitors.
Pro forma for the closing of the transaction, we will have approximately $2 $5 billion of annualized rental revenue for every $1 billion of acquisition to a single credit on industry, our exposure to that traded on our industry will increase by approximately 2% compared to around three 5% based on our current size.
By leveraging our size and scale, we continue to effectively execute through our international platform, we have a healthy acquisition volume in the U K.
Fundamentally we are replicating our U S business strategy seeking to curate a high quality real estate portfolio leased to leading operators in economically resilient industries.
Our total first quarter acquisition volume includes approximately $403 million of international acquisitions in the U K, which brings our total investment volume to more than $2 billion.
Since the first transaction, we closed in the UK in 2019.
Our international pipeline has accelerated even more quickly than originally anticipated. This quarter's international acquisitions volume represents nearly 40% of our total investment volume during the quarter.
I'll figure that is truly incremental to the U S business and one that we expect to growth.
Now I'll pass it over to Christine to provide financial updates.
Thank you Sumit.
I'll start with some high level background, and then move into our financial results for the quarter.
We are the only net lease free on the S&P 500.
One of the top 10 largest U S REIT by enterprise value.
And the largest company in the net lease REIT sector.
Upon closing, our recently announced market with NAREIT.
Realty income is expected to be the sixth largest free and the R&D in terms of equity market capitalization.
Our size and scale.
Johnson with our conservative balance sheet and financial strength.
Our reported net to a credit rating by the major rating agencies.
And our 3 billion multi currency revolver granted ample access to world price capital.
That allows us to opportunistically raise permanent long term capital when the markets are most favorable.
During the quarter.
As the crop net may $670 million.
An overnight equity offering right.
Our financing risk by pre funding our active global investment pipeline.
In January 2021.
We completed the early redemption of all $950 million three on a quarter percent notes due in 2022.
To take advantage of attractive borrowing rates in the fixed income market.
While reducing our near term financing risk.
This redemption was primarily funded through our December issuance of $725 million.
Senior unsecured notes through a dual tranche top rank.
Five year and 12 year note.
Which achieved record low U S dollar coupon rates on the REIT sector.
For each of those tenders.
As a result, our fixed charge coverage ratio I am pleased to report has hit an all time high at five eight times this quarter.
We believe funding our business with approximately two thirds equity and one third debt contribute to maintaining a conservative balance sheet.
We ended the quarter with net debt to adjusted EBITDA ratio of five three times.
<unk> two times on a pro forma basis adjusting for the annualized impact of acquisitions and dispositions during the quarter.
And our near term debt maturities remain minimal with only $26 million of debt maturing through year end 2021, excluding our commercial paper program and borrowings outstanding on our revolving credit facility.
At the end of the first quarter, we had full availability of our $3 billion.
Net currency revolving credit facility.
$675 million outstanding under our $1 billion commercial paper program.
And over $184 million of cash on hand.
Providing approximately $2 5 billion liquidity available to capitalize on our Atkins global investment pipeline.
During the quarter, our business generated 86 at <unk> per share and we are maintaining our 2021 <unk> per share guidance of $3 44 to $3 49 net.
On a stand alone Realty income basis.
And adjusted for the expected merger.
Remember, we currently have 37 of our 79 theater assets on cash accounting.
The 37 theatres represent about $25 5 million of annual rent remaining in 2021.
And <unk> $33 2 million as allowance for bad debt on these assets.
Net of $1 9 million.
Lying rent receivable.
In total this.
$58 $7 million.
Approximately 15% that is not currently included in <unk> per share guidance.
We are encouraged by the recent momentum in the theater space such.
Such as increased nationwide openings and the release of blockbuster films.
Most recently Scottsdale ROE vs Com brought in approximately $49 million during the opening weekend.
Five case, specifically Wednesday to Sunday and generated more than $390 million in revenue within the first two weeks of its global relief.
Turning a profit of more than $200 million.
However, until we are confident these particular theaters can continue to pay us contractual rent we will continue to recognize revenue per the 37 theaters on a cash basis.
As the monthly dividend company.
Net be remiss not to discuss the dividend when providing business result.
In April we declared our 610th consecutive monthly dividend.
And we now increased the dividend 110 times since our listing in the New York stock exchange in 1994.
Since 1994, we have increased the dividend every year growing dividend per share at a compound average annual growth rate of approximately four 4%.
And as a result in increasing the dividend every year for the past 25 consecutive years.
We are proud to be a member of the exclusive S&P 500 dividend aristocrats index.
Which consist of only three rate and 65 companies overall.
I would now like to hand, the call back to CMA.
Thank you Christie, our first quarter results continue to highlight the incredible opportunities afforded to us by our size and scale, which uniquely position us to be the global consolidator in our highly fragmented net lease space.
And we believe the merger will enhance our positioning to be just that.
Our positive results as well as our positive business momentum and a strong outlook energize our talented team to continue expanding our existing verticals, while finding new swim lanes through which the business can grow at.
At this time I'd like to open it up for questions operator.
As a reminder to ask a question on the two press star one on your telephone.
Draw your question press the pound key.
Please limit yourself to two questions. If you would like to ask additional questions. You may reenter the queue. Please standby, while we compile the Q&A roster.
Your first question comes from Greg Mcginniss from Scotiabank.
Hey, Sumit.
Very acquisition dramatically increases your exposure to casual dining tenants to seven per cent of ABR, which is an industry, where other reits seem to be limiting exposure.
What makes you comfortable with acquiring all of those tenants.
That's certainly an area that we spend a fair amount of time focusing on Greg when we were looking at NAREIT.
The biggest contributor to that 7% is red lobster.
Looking at where Red lobster is today versus even where it was a year ago gave us a fair amount of confidence that red lobster has turned the corner from being privately owned private equity owned two being owned by a company out of Thailand Thai Union.
And the credit enhancement that it achieved the results that it is not posting the fact that it gave that it paid 100 per cent of the rent in the fourth quarter. Two day read all of that gave us confidence that its too on the corner on being vertically integrated organization, such as probably Union is.
Made us feel like 7% is the number that we can live with but the goal here Greg will be over time to continue to reduce that just like we did with.
Casual dining concept, which used to be in the high single digits and today represent less than 3% of our overall.
Registry.
And that will be the goal with with you.
On a pro forma basis being up two 7% continuing to reduce that back down into the low single digits.
Okay. Thank you.
And then second question given less concern about tenant concentration issues. Following the very merger are there portfolios in the market place today that you now feel more comfortable pursuing.
Are those types of portfolios already considered an acquisition guidance and then how much volume do you think those types of portfolios could potentially contribute to acquisitions each year.
Yes, there's a bunch of questions you've asked that Greg.
The question is we've talked about how pro forma for this acquisition.
John.
It allows us to pursue larger transactions.
I will say that you don't have multibillion dollar transactions coming in every week, but when you do.
They can be a step growth opportunity just like a consolidations in our industry.
But given our size today.
A multibillion dollar transaction.
We were somewhat constrained pursuing that even if it checks all the other boxes I E. We'd like the credit wed like the operator, we like the industry. We like the makeup of the real estate, we'd like the rent composition et cetera et cetera.
You feel constrained just given how much of your portfolio concentration gets impacted by a single tenant with once you start to increase your platform.
On the ability to absorb larger transactions when they when they present themselves certainly enhances.
And there have been opportunities and I don't want to get into details.
Even in the past 12 months, there have been opportunities to pursue transactions.
Given everything that we have relationship to.
To check the boxes across the spectrum.
<unk> was still constrained by the allocation that we had.
To be able to pursue this particular transaction single handedly and those are the types of constraints that do get alleviated the larger your platform becomes.
And it does.
Low you to be able to present yourself as a one stop shop for some of these very well capitalized businesses that.
You want to continue to be that one stop shop, which we have been in this one example that I'm referencing.
So yeah.
I do think that you know.
Both of these consolidation that it will enhance our position to pursue transactions that we were.
Somewhat constrained to do so in our current size and scale.
Thanks Sumit.
Sure.
Your next question comes from Katy Mcconnell from Citi.
Yes.
Hi, Katy.
Could you update us on the portfolio of office assets to a plan to spin off with the merger and now it could be all about me up on what have you been able to gauge as far as buyer and chats and your ability to potentially strawberries from Tom.
Sure.
Kate it's been.
It's been three day three business days since we made the announcement but.
Thank you for asking the question Yeah look we've been pleasantly surprised by the inbounds, we are still in the process of collecting those inbounds and trying to figure out what's real from what's not true.
We have been very clear that our path that we control is the spinoff Pat to answer your question more directly it's essentially all of our office assets along with.
The vast majority of the of the varied office assets outside of the six assets that are constrained by <unk>, which is cross collateralized across multiple asset types. So.
Outside of those six our goal would be to to basically spinoff.
All of the remaining assets, which switches.
Right around 97 properties.
$180 million to $183 million in Rand.
Weighted average lease term circa four.
70, 677% investment grade tenants.
That's the makeup of the portfolio.
But.
As we.
As we had thought would happen once we once we announced there have been inbound calls we had just gathering the information, but it is still too early to tell.
What's real from what's not.
We are going to continue down the path that we control and if something were to happen in the meantime, that's correct, but it's too early to tell.
Okay I appreciate that color.
And then can you go on a more about the decision to enter the Hawaii market now and whether you will look to increase scale, they are more meaningfully or potentially pursue on the industrial opportunities there.
Yeah Katy.
It's just.
It's not something we intentionally pursued in this particular quarter we've always.
Two Ceos ago, Tom was from from Hawaii, and the inside joke was how come we don't have any properties there.
Now Jonathan Pong.
As our resident Hawaiian.
The joke has continued but it really was a function of the bright opportunity presenting itself at the right time.
With the with a partner that we really liked when.
When we underwrote their business, we underwrote their performance, we underwrote the locations.
It was just the right time on the right place and it just so happened that it closed in the first quarter there wasn't any grand design to be able to come out and make the kinds of announcements that behalf on we've been very opportunistic very lucky in some ways I'm very grateful to now be able to say that we are in 50 states but.
That to us was not as important as finding the right transaction.
<unk>.
On this particular transaction that allowed us to go to Hawaii, certainly checks all the boxes. So we are very grateful for that.
Okay, great. Thank you.
Sure.
Your next question comes from Ronald Camden from Morgan Stanley.
Hey.
Good afternoon, just two quick ones from me. The first is just a.
Just on tenant health in general on the portfolio, maybe if you could provide some updated thoughts on.
How you are feeling today, maybe versus six and 12 months ago, and then digging a little bit deeper into some of the theaters and looking at the collection rates.
There may be some some insights is take the collection rates may have been a little bit lower than what we would've expected maybe what what's going on there with the theaters.
Sure Ronald Thank you for your question.
Look our.
Watch list is right around 5%.
And.
The biggest contributor to that watch list is the tinder business. So they are very much tied.
Our collection is also largely a function of the collection in the theater business.
We feel you asked me to give you a reference point as to how we see it about the theater business today versus.
When we first got into the pandemic.
We feel a lot better.
Today than we did then.
There have been actual examples here on the U S.
Which were preceded by examples playing out in China and in Japan.
Which lend credence to the hypothesis that we had.
The peer to business once the contents, what's starting to get released.
On the social distancing norms were relaxed.
Our business was April was going to be able to bounce back that thesis is largely proven out to be the case Ronald I mean, if you look at the.
The only one example that we currently have a big blockbuster movies that came out.
Which was the Godzilla vs com.
In the first five days of generated right around $49 million.
We've been tracking how it has done subsequent to that as well and it's right in that.
Hi, 80, right around $90 million is the collections here in the U S theaters, if you look at it globally.
It's close to $390 million.
And the budget to make that movie was right around 180 $190 million, so $200 million costless.
Largely being gathered through the.
Through the <unk>.
Theater release and that just continues to lead the credence to that has content starts to come in as these theaters are on are allowed to open AMC is largely open here in the U S.
Regal is still not.
Regal is still targeting.
Late mid to late May to open up all of its theaters.
And so we do believe that collection is going to become a function of the theaters opening and based on the discussions that we've had with our operators.
We continue to feel very optimistic.
That in the near term those collection numbers will start to go up.
But look we're also blessed with.
With our balance sheet too.
Len Grace to some of these operators as long as we believe that their operating model is going to two.
<unk> come through and it's going to be a viable business model going forward and we genuinely believe that the theater industry and specifically these two operators are going to be viable operators going forward.
And so if we have the ability to lend our balance sheet.
Give them a little bit more grace in terms of stabilizing their operating business model.
That's what we've done.
And we feel very good about that decision.
And Brian on the only thing I would add Thomas.
Comments is just.
Reminder, to the team that's on the line is that our theater portfolio has really high quality.
There's over 80% of the theaters in our portfolio that are in the top two quartile exclusivity operators.
Footprint.
And as Tim mentioned and he is open but it limited capacity right now and Regal theaters will be opening towards the end of May.
And to that point, we're cautiously we remain cautiously optimistic, but there's one thing I want to point out that.
When we take a look at the momentum.
As it relates to the collection rate in theaters.
It's steady and improving so stabilized from here and we were about 10% collection and then throughout the quarter, we gained from momentum to build towards 16%.
So we will look forward to reporting more when we come to the second quarter.
Great. That's helpful. My second question was just going back to the <unk>.
<unk> merger.
Maybe just a simple question, but just.
How can you help us understand.
How your real estate and the quality of your real estate the quality of the retail assets that you own compares.
To those of theory.
Youre going to be taking in right how should investors think about <unk>.
<unk> and contrasting the quality of those portfolios spin.
Specifically the retail piece thanks.
Yeah.
Ronald they've got three and a half thousand properties that has spin.
Constructed.
Over the last 11 years since day since it became public.
Clearly there are areas of the portfolio, one of which we touched on.
Has turned the corner, but it wasn't something that we would have pursued in isolation six years ago when they when they chose to do that transaction.
But by and large I would say we were pleasantly surprised when we underwrote all of their assets all of their operators.
At the quality of the portfolio they had and there was an arch to be made here for whatever reason and we are grateful because it allowed us to create a lot of value for our business.
They were trading at a massive discount to what we believe is the inherent value, especially of the retail and industrial portfolio.
And so you know.
The other point I would like to highlight is the fact that they are complementary.
Two our focus this is why things like convenience stores, which we are big fans of with certain operators.
Qualify.
Allows us to go from 12%.
Two 9% pro forma for the combination.
Allows us to take out grocery from 10% to 8% because they didn't they don't have those.
On locations in their portfolio.
And so that certainly helps us create.
Additional capacity plus on the theater business. They didn't have much of an exposure. So it allows us to bring down on theater exposure from 50 756 to three 8% from.
We're just starting to get closer to the optimal allocation that we have been talking about over the last couple of quarters.
So pleasantly surprised on the upside which is one of the main reasons why we decided to move forward and we're so grateful that we found unlike minded person and Glenn and his management team.
Two to move forward with the transaction.
Re genuinely believe is a win win for both parties.
So yeah Super happy to absorb that retail and industrial portfolio into the pro forma Realty income.
<unk>.
Super helpful. Thank you.
Sure.
Your next question comes from Andrew <unk>, St Juste from Mizuho.
Hey, I guess good afternoon out there.
I'm talking about.
Hmm.
Hello.
Can you guys talk about the acquisition cap rates a bit more here in the first quarter will be the low 5% overall, 4.9% U K I believe last quarter, you suggested that cap rates.
It would be for this year would get back would be similar to 2020 levels or closer to maybe 6% depending on mix.
And then Youre seeing increased competition, we've heard of financial buyers getting 85%, 90% LTV financing ABS market.
Maybe can you talk about the market and what role that competition.
From financial buyers playing on the pricing for the assets Youre looking at and is it specific 20 sub sector of our industry.
Low 5% cap.
Cap rate is what we should expect for 2021.
Yes.
So handle quarter over quarter. These numbers are going to vary and it is largely a function of the mix.
If you are going to be heavily industrial focus the cap rates are going to be on the lower end. If you are going to be more retail focus it'll be on the higher end on making general comments, obviously, there are exceptions to even within even to what I just said.
But if you look at what drove the UK cap.
Cap rate it was largely to industrial transactions that we did with.
With the same seller.
We have a very good relationship with.
One was an industrial asset.
In the greater London area.
On the highly sought.
Purely on last mile.
Location.
We got it at.
Our cap rates, we felt very comfortable owning this particular asset another one was in the suburbs of Birmingham.
It was its leased to a single a credit.
<unk> Fantastic distribution center below market rents.
Something that we feel like is going to be super additive to our portfolio going forward.
And that's what really drove.
The cap rate.
Two to where it was had we excluded those two on.
Cap rate would have been closer to where we did our fourth quarter U K transactions, which was I believe if I remember correctly by six seven cap rate.
So it really is going to be a function of mix, it's going to be a function of which geography dominates et cetera, et cetera, but I don't think you.
Should you should expect the cap rate, we posted in the first quarter to be.
The new norm.
Still say that we should average right in that mid fives to twos.
Slightly above that.
That would be the goal and in quarters, where we do some more higher yielding stocks because it's things that we found that people are not focused on yet we could see a potential six.
But it really is going to be a function of the mix. It is going to be a function of.
Asset type lease term geography, all of those things that go into into defining what the what a quarter cap rate.
<unk>.
The bigger point here is.
This is the second quarter in a row, where we've done a $1 billion.
And I've seen a lot of numbers coming out talking about Oh in order for them to get to the high single digit growth rate.
They're going to have to do $4 billion of acquisition.
We welcome that challenge in fact, we are excited about that challenge.
And.
We've already talked about what.
Creating these new verticals for us new markets of growth for US has done to our sourcing numbers, which is not translating into actual closings.
So for us.
The numbers being being posted yes for most net lease businesses Thats, a staggering number but for us it's something that we welcome.
And we also agree with the market that it is for us to show to you.
Net we are capable of doing this on a quarter after quarter after quarter basis, but that's where the fun part is for us on the team.
We look forward to that challenge and we look forward to posting numbers with assets that doesn't compromise. What we had said is our risk profile.
And that's the key message here.
That we are doing all of this and we are growing our platform and we are growing on our portfolio.
With the right type of industries right operators right geographies right growth rates all of the things that will create sustained value over the long term.
So.
I know you didn't quite ask that but I just wanted to make sure that we had put the answer on cap rates in context to what it is that we are trying to do.
And the sustainability of what Theyre trying to do so forgive me for that tenant.
No that's perfect. Thank you for the color I appreciate it can.
Can you also talk a bit perhaps.
Are you a bit more willing to day at all the kids.
Consider industry that you, perhaps put off to the side over the past year on year aftermath of COVID-19, perhaps.
Expanding your investments playbook from here.
I don't know if its more entertainment or experiential or things that have been.
Less.
COVID-19 resilient, but given the improving.
Vaccine distributions the economic expansion just curious if that view has changed at all and if theres any specific industries you would point to.
And on one of the things that will distinguish this team I think on I believe in it.
Is the fact that we will always remain humbled.
If data is changing on the ground if trends are changing we're constantly trying to mark to market.
But what we don't want to do.
Is over index to any near term phenomenon just like we did over index to the fact that hey, the theater business on the health and fitness business really took a took a beating in an environment, where you have social distancing requirements.
And does that mean, we should go down to zero in both those businesses. The answer is no.
And so what we are trying to figure out is what are the trends, especially given the long term nature of the leases that we enter into.
What is the trend long term that we are going to underwrite to.
And just because something creates.
On potential opportunity near term, if we can get comfortable with the long term prospects, we will largely stay away from those types of situations, but that doesn't mean, we don't get a few things wrong.
Hindsight, we don't go back saying Oh.
Should have played that.
Current way because our conclusion was inaccurate.
But we I believe have got more things right than wrong.
And that has served us well.
So the answer to your question is without getting into specifics that we are constantly trying to upgrade our thesis to reflect what's what's on the ground, but we don't try to over index to it without taking into consideration the long term impacts of those those immediate trends that we're seeing.
I'll I'll throw something out there, which is the exact opposite of what.
You know what you are suggesting.
There is an opportunity in the office sector.
Now on where Youre going to go into the office sector. No. There's a reason why we have said we are going to be spinning off all of our office assets, but I do believe that given the environment today and given how negative.
The sentiment is around the office asset time, there is value to be heck.
If somebody is willing to take a longer term.
Perspective on what his office going to look like.
And that's the reason why we want to create a spinoff if that is the route we end up eventually actuated.
We want to set it up for success.
And it is a play on what we are seeing near term and then it's forecasting out that trend line to see what do we think it's going to happen to office five 710 years from now.
Where do we see growth, yes growth I use that word with office.
Where do we see opportunities.
And.
There is an argument to be made that could play out so Tom will tell.
Any perspective, you want to share on the casino and I know, it's been asked in the past, but I'm curious.
You on that sub sector is any different or any more willingness of day to act on that.
Yes, I'm not going to talk about specifics handle you've always asked the very specific questions and I've tried to stay away from it you asked me about M&A.
Alright did M&A for you now.
Paul.
[laughter].
No no I'll stay away from specifics handle thank you though.
I appreciate the time.
Sure. Your next question comes from Caitlin Burrows from Goldman Sachs.
Hi, there.
Hi.
Net you gave some detail to explain the relatively lower cap rate in the U K this quarter.
But theres also.
So stated tax burden in the UK, which impacted numbers in the quarter. So I was just wondering kind of big picture. If you could go through.
Why the UK investment activity makes sense to you bigger picture and then also how we should think about the associated tax expense going forward.
Yes, very good questions case, ma'am. Thank you I should have actually.
<unk> My my answer on the U K, giving a little bit more color on the structuring side of the equation.
So.
We went into the UK, recognizing that theres going to be an associated attract tax leakage and when we underwrite transactions. We take into account what is our effective tax rate what is the statutory tax rate, what's the effective tax rate how much I'll be really making in terms of actual spreads.
Et cetera, et cetera, and of course, comparing it to the cost of capital, which is also much lower in the UK.
And seeing if it made sense it made a lot of sense.
And by and large I think we are tracking to the effective tax rates that we had.
Shared with the market two years ago in April of 2019.
What I would like to add Caitlin is.
There is.
The change that is being contemplated.
That would actually increase.
The statutory tax rate in the U K market, but what we have been exploring and on.
And hopefully we'll be able to implement in the near term.
Is restructuring are getting realty income limited the legal entity that that his house there.
Where we would actually end up potentially saving 400 basis points off of our effective tax rate.
So do you expect to see this.
The taxes being paid in.
In the UK continuing to go up absolutely you should.
But not at the same rate as you have seen over the last two years, we are getting more efficient we are structuring our.
Our transactions going forward in a manner where.
We are actually going to see on.
On an effective basis and a decrease in the tax leakage associated with our investments.
And we are constantly looking at how are we going to be financing. This transaction and does it still make sense and the answer is a resounding yes. It does.
And that's the reason why we are continuing to do what we're doing.
Got it Okay, and then on <unk>.
Switching topics day guidance that you guys have put out assumes that same store revenue improved as the year gross on there was commentary earlier on.
Hopefully improving theater collections on performance and acquisitions are expected to continue but the <unk> guidance kind of barely implies any growth from the <unk> run rate. So I was just wondering why is that how does the improving same store revenues on acquisitions not translate into more meaningful on ASF.
Per the guidance or is the assets low guidance just pretty conservative at this point.
Sure.
That's an opinion.
I'll, let you conclude that for yourself, but I do think Kristi mentioned as too.
The 37 assets that are on cash accounting so so much.
The improvement that could play out in the future has not been sort of reflected in the guidance that we have shown but nor have we changed on a cash accounting on those 37 assets. So we we really if you want to use the word conservative fine. We just really wanted to see actual collections go back up to levels.
That warrant a change in our thesis around cash accounting versus not and then that will certainly translate to two.
Higher <unk> per share trend lines.
But we.
We we tend to be a little bit more deliberate and.
Yes things are looking very optimistic.
But on.
Until it's not actually starting to reflect in closed monthly statements.
We are going to stay the course and.
Obviously, what we have and the reason why we haven't adjusted as for the merger is because first and foremost there are conditions involvement.
And even if this were to close it won't happen till the fourth quarter.
Which clearly would have a very minimal impact this year and so.
So for those reasons, we have kept the guidance.
Exactly the same we want to digest, what we just announced last last week.
We also want to get another quarter under our belt and then we would revisit.
Earnings at the end of the second quarter and and share with you what on Earth.
Maybe just thoughts on on that.
Okay. Thank you.
Sure.
Thanks Caitlin.
Your next question comes from Rob Stevenson from Janney.
Hi, good afternoon.
Do you guys currently have as of March 31st 131 vacant assets and presumably youll have additional assets become vacant over the remainder of the year ordinarily some percentage of that you guys keep a relief from some you sell and move on given the size of the very transaction on the integration progress process. How do you guys think about your team's bandwidth and maybe just selling.
A greater percentage of the vacant assets, if they can't be released easily and moving on.
And focusing on the integration versus the time energy and even the potential upside from leasing vacancy.
We are very comfortable executing exactly the same business model that we have we have always said that you know if you wanted to run a business at 100% occupancy we can.
But that is not value optimizing solution.
And the reason why we have also shared with the market are.
Real estate operations team is the largest in the company is to be able to do the things that we want to do.
That is the reason why we have always said that 98% is the is the right occupancy level for us because we are going to be repositioning assets, where we can create.
And then these numbers get buried but 140% to 170% <unk>.
Recapture rates on rent just because of these repositioning that we were able to do but he asked it takes time and yes that means more youre sitting on more non occupied assets, but we are very comfortable doing that if that is the right economic solution to do so.
And just to put things in perspective that 131 was $1 40.
<unk> hundred 40, <unk> at the end of the fourth quarter, because we got 65 of our MPC assets back.
And the team was able to not only absorb the.
The first quarter.
Explorations, but make a dent on a pretty good one.
On on those.
Assets that were handed back from the NPC transaction.
I'm Super comfortable.
With with the team that we have and the asset management team that is led by T. J.
They are a phenomenal growth and what we would like to be able to do is when we absorb theory is to be able to implement the same business model.
Which is the reason why we think we want to hold on to.
A lot of their folks and.
And you know potentially share our business model with them.
On trying to generate the same types of results that we've been able to generate on a standalone basis.
That is another area that we can we can enhance.
Through this through this combination.
Okay and then second question how are you thinking about going forward, it's been mostly non retailers of late and even overall, it's a pretty small piece of O today about to get much smaller with the acquisition does that do you need to keep that to fulfill obligations to the customers does that go away how should.
Would we be thinking does that is there a chance that that gets bigger going forward for you guys.
Rob I I missed the key word because it was a big deep.
What is it that you said that we need to keep forward and it's a very small part of our business the development business just balance yes.
It's mostly non retail and it's really even overall, a really small piece of O today going to get much smaller do you grow that does that need to stay because of commitments to customers et cetera.
How are you thinking about that business.
Very good question, and we hope to grow that business.
It's about a $200 million business today, and you're absolutely right, that's not very large compared to the balance sheet that we have.
But.
Some of the repositioning as I alluded to some of the relationships that we have with existing industrial clients, who want expansion capabilities.
Some of the relationships that we're developing with developers.
To provide a capital source that could be a take out all of that is incredibly valuable to us and I would love to see with the bigger platform.
Make this three X forex on what it is today.
On behave.
Another contributor of value to our business.
And.
So.
We have a team that we have continued to grow and through this combination.
We will potentially grow the steam even more so that we can we can continue to enhance value going forward even while.
Just working on our own existing assets and going back to your previous question working on on vacant assets or soon to be vacant assets and doing repositioning that requires an in house expertise on the development shrunk. So we would certainly hold onto it and grow it.
And on.
And potentially growth.
Grow the allocation from where it is today.
Okay. Thanks, guys I appreciate it.
Sure.
Thanks, Tom.
Your next question comes from verticals, yes.
Hey, guys.
Sumit following up on your call.
Christie how are you.
Okay.
Doing great.
Just following up on your comment earlier about the $4 billion on acquisitions. This year that you've seen some analysts write about I'm. Just curious are you seeing anything on the market that could call the slowdown in the pace of share transaction activity on the near term.
Just seems like you're on pace to well exceed the minimum $3. Five you guys guided to so just curious what youre seeing there.
Brent we are very optimistic.
To be very honest with you we're not seeing anything we are obviously.
Following some of the same rules coming out of DC and how it is going to have an impact et cetera, we do not see any of that translate into the volume being sourced.
And our belief.
Not only meeting but potentially exceeding.
What we have shared with the market is on our acquisition target.
We started the year and I think Brent if you recall when we came into January we shared with you what our pipeline looks like you know.
And how optimistic we were that optimism has just continued to grow. So we are super excited about.
Not just the sheer volume, but the quality that we're seeing on the quality that we are being able to get over the finish line. So.
On the platform is working.
Okay, perfect and then just digging into the transaction activity a little bit more could you talk about what youre seeing for some of.
On the troubled tenant asset classes.
Reopening plays out on rent collection rates there improve are you seeing any of those assets starting to trade.
On fitness movie theaters et cetera sure.
We've certainly seen.
A couple of trades on the health and fitness side, especially with the more established operators.
We've seen a few vacant assets on the on the theater side sell.
So yes.
People are getting much more optum.
Optimistic about the future and are willing to buy vacant pieces of land.
With a building and reposition it.
That optimism is starting to filter in.
Into into the acquisition arena, but that's not an area that we play in.
But it's certainly it's certainly something we're seeing.
Okay. Thank you.
Sure.
Thanks Brent.
Your next question comes from West well day from Baird.
Yes.
Hi, everyone.
Few quick questions for you.
Other efficacy looking at the industrial same store revenue looks like it's been negative 40 basis points last year on a continued into this year do you expect that to inflect weather this year.
Yes.
Largely driven by this one asset.
Cash.
We had incorrectly calculated the CPI adjustments to it and we when we realize on mistake and of course, we had collected rent on that.
We went back to our client and we shared with them that look there was a there was a mistake.
And we gave them all.
We readjusted the rent going forward.
And Thats really what youre starting to see play out.
And so.
Obviously, the client was incredibly happy about us.
Coming out and sharing this information.
But thats really what youre seeing play out if you look at the actual leases on the industrial front from they have a lot more growth built into it than even on retail leases students. So the same store rent numbers should actually on a normalized basis West I would expect it to go up.
Not not enough down.
Got you and then maybe it's early but I'm just curious about the potential office spinoff, how the capital structure would look on what that means.
What that would mean for OS pro forma leverage.
We are.
We are absolutely focused on maintaining on <unk> III a minus rating.
I believe board the rating agencies came out and reestablished the.
On the ratings as well as the outlook.
Post the announcement, we made last week.
And we are we are very much focused that pro forma for the spin.
We will continue to maintain those.
Those those ratings because.
Even pro forma for the spin the pro forma company is going to be close to $50 billion in size.
And.
And we'll have.
Leverage metrics that is equivalent if not better than what where we are today. So it is super important for us to maintain our ratings.
Got it thank you both.
Sure. Thanks.
Thanks, Brett.
Your next question comes from Linda Tsai from Jefferies.
Hi, Linda Hi, Hello, Christy Hi, Sumit.
Maybe following up on your earlier comment that you handle you can handle on welcome large acquisition volumes for this quarter, you source 20 billion and invested in 5% does.
Does this 5% or 1 billion executed to 20 billion sourced ratio remained consistent post merger.
I hope it gets enhanced.
<unk>.
I think I said this last week.
That.
We're very REIT has been spending a fair amount of that time is not exactly a 100% of an overlap of where we spend our time.
So we would like to be able to continue.
Continue to leverage their platform and their ability to to.
To play in a ZIP code that we haven't spent a lot of time, because we are finding plenty of opportunities in the areas that we really want to focus on.
So.
My hope is that.
Pro forma for the for the combination.
The platform will increase in size and the area of focus will increase and therefore, we might be able to create a trend line that is a step up from where we on today.
But that is down the road.
Wanted to stay focused on where we are today on the platform that we have currently.
And if you look at the ratio of what gets close versus what gets source. We have generally been in this 4% to 7% to 8% Zip code.
Four four.
For many quarters now I mean, there have been quarters, where those numbers may have been.
No.
Higher or slightly lower perhaps but it's generally in that ZIP code and and we have the infrastructure to two.
Absolutely.
Deal with that volume.
And deal with.
With getting on.
Our share of that volume over the finish line.
And we haven't remained stagnant that's the other point that I know thats not very obvious from the outside our team has grown we have.
On a complete platform now in the UK, which is in addition to the platform that we have in the U S, which didn't exist. So the platform has continued to grow.
To absorbed is higher volume.
Of analysis.
Thats being asked on this team so so far so good.
Thanks, and then my second question is with G&A at about four 5%.
Have a sense of how low that could go maybe a few years out post merger.
Yes.
Yes.
We've talked about the G&A synergies in that $45 million to $50 million.
On a cash synergy on 735 to 40.
Link Theres some analysis that that the team has done where we show you that the G&A to gross asset value potentially drops by one third.
Going from 33 basis points to 23 basis points to 22 basis points.
And.
That is the goal.
We absolutely believe in that.
Larger platform becomes.
The more scalable it is and.
Therefore, it should translate to G&A numbers, continuing to go down, but how far down does it go.
I can tell you you know, it's also going to be a function of.
Do we continue to add new swim lanes, if we do we need the infrastructure to help support that.
And and if it keeps our ginnie elevated because we are still not true reaching this normalized level of what this business on platform is capable of doing I'm totally fine.
Having a journey for us.
But on a normalized level, if we have exhausted all possible swim lanes.
Then who knows where this thing can go.
I don't have a precise answer for you Linda.
Thank you.
Sure.
Thanks Linda.
Your next question comes from John <unk> from Ladenburg Thalmann.
Hey, John Good afternoon, Hasnt got it.
Good day.
Just a quick one for me.
Outside of office, how much roughly speaking of the very portfolio do you view as being a target for capital recycling as you look to manage the portfolio.
You know I think I've answered this question in a different way in terms of.
How much did we like the industrial in the on the retail portfolio that will be part of remain co going forward.
We don't see their makeup being largely different from ours, except in the areas that they have chosen to focus on that.
But the more we underwrote those industries in the on the <unk>.
Actual operators that they have exposure to.
On the more comfortable we got that overall this portfolio is one that will be very proud to absorb so John I don't have a precise answer.
Could you see a corresponding increase in our.
Capital recycling that we manage through the disposition you could but that will be more of a function of the size of the platform has just increased rather than if getting disproportionately larger because theres a lot more assets on their side that we would want to recycle that.
Time will tell but I suspect that it will be commensurate with what we have established.
On a standalone company today.
Okay.
All my other questions have been answered so that's a great. Thank you. Thank you John.
Thanks, John.
Your next question comes from Joshua.
On Bank of America.
Hey, John Hey, Christy Hope you're doing well.
We carry less.
Do you think about Europe, now that you're a larger entity and just hit the $2 billion mark over in UK.
Are you thinking about accelerating the push into the rest of the Europe at this time or is there.
Some of it a hurdle that you would be looking at.
Paul.
Josh that's a very good question and I do want to answer it.
What we were planning on doing on a standalone basis has absolutely not changed because of.
The announcement, we made last week I don't believe that it accelerates our desire to go into the rest of Europe, just because of this particular merger.
Our desire to go to other geographies and other markets are.
Are largely being driven by our underwriting our ability to absorb new markets. The team that we have in place the maturity of our understanding of these various different markets, that's what's driving our desires and.
So yes could we do more because of the scale benefits of absorbing <unk> $15 billion platform. The answer is absolutely, yes, we can do more.
And so so I think that's where the benefit comes but I don't think.
<unk> trying new things is triggered by the fact that we have a larger platform off of which to try it. So I just I just wanted to make that nuance points.
Josh, but it was a great question and I'm glad you asked.
Great I appreciate it.
Thank you Josh.
Thanks Jess.
As a reminder to ask a question press star one.
Question comes from harsh <unk> from Green Street.
Yes.
Hi, guys.
Hi.
Tom You mentioned that you are looking to growth the development side of the business or just sort of looking at the initial units on those.
This quarter, there was roughly equal to the.
Yields on the acquisition I'm, just trying to understand.
On the thread over cost over your cost of the average that you'll see on the acquisition side versus what youre aiming towards on the cash on the development side Lockdown.
Yeah harsh very good question, but again, it's a function of the mix.
The development dollars are going.
If it is going towards industrial assets, which you will see that it is the vast majority of the capital is going towards Takeouts.
And those cap rates on if they have a five in front of them.
It's a great outcome.
Because guess what happens once these assets are fully developed and you go out into the open market and you try to buy it from the open market.
It potentially has the low fours.
Even a three handle in front of it.
And that is the reason why we feel like yes. These cap rates headline cap rates may look low but.
If you really dive in behind the numbers and you're trying to figure out what is the product that they are being able to get through this development funding takeout funding whatever you want to call it.
Versus what could be by the scene particular asset if it were available today.
There is still a 100 basis points, maybe 50 basis points, if you want to be conservative uplift that we're getting.
By partnering with some of these very well established global developers.
So that's really where the value creation is to answer your question more specifically what do I see the yield on development. If you look at retail when you look at retail development. It depends on whether it's a repositioning our greenfield on what have you.
On repositioning.
That's where the maximum value creation of course, we already have the piece of land.
We go down the path of creating.
On <unk>.
Repositioning an asset with the expectation that a.
And I threw some of these numbers out at you.
We could have rents.
Compared to the.
The pre repositioning of 150 200, even 300 basis on a 300 percentages points.
So that's the kind of uplift in value, we could we could generate through this not that is a small portion of our business a very small portion.
But I just wanted to put in perspective that you'd see a blended number.
But if you go behind the number there is a fair amount of value creation.
And largely we want to be viewed as a one stop shop by our tenant.
Who know us as landlords that hold assets for the long term and if we can help them.
Harness on our vacant asset portfolio by repositioning it for their needs, we want to be that serve them and thats. The reason for having this but in terms of how big is it going to become what is the trend line going to look like.
It's going to be a function of.
What dominates in that one given quarter.
That's interesting and then one more from me on.
On.
On the debt synergies from some of the deal.
Given that you have a lower cost of capital.
Could we expect to see a higher leverage ratio on your UK assets than in the U S.
No.
Again, it goes back to our ratings harsh if you want a guiding principle looking at our balance sheet on a fully consolidated basis, and we want to be right down the fairway, which keeps on reading agencies very happy.
Yet it allows us the maximum flexibility to run on business, but we do not want to do anything thats going to compromise our a minus eight III, leading now the mix of where that debt comes from could absolutely change a lot more of it could come from the U K given the the arb between a tenuous sterling denominated.
Unsecured bond vs.
U S unsecured bond.
And we may choose again, just to match fund our assets with.
Locally denominated capital, we may choose to over lever.
Some of those assets, but there is a.
Threshold beyond which we are not going to go even on a standalone basis, but yes. We can certainly have more of a mix coming from the U K given the lower cost and then the U S. And then if you look at it on a fully consolidated basis, it's going to have the same profile that you would expect on <unk> minus rated company I hope that answers your question.
That's helpful. Thank you.
Sure.
Thanks harsh.
This concludes the question and answer portion of Realty income Conference call I'll now turn the call over to Sumit Roy for concluding remarks.
Well. Thank you all for joining us today, and we look forward to speaking with each of you soon thank you so much bye bye.
This concludes today's conference call. Thank you for participating you may now disconnect.
Okay.
[music].