Q2 2023 Realty Income Corporation Earnings Call
[music].
Good afternoon, and welcome to the Realty income second quarter 2023 earnings conference call.
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I would now like to turn the conference over to Steve Becky Vice President of capital markets and Investor Relations. Please go ahead.
Thank you all for joining us today for Realty income second 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 statements that may be considered forward looking statements under federal Securities law. The company's actual future results may differ significantly from the matters discussed in any forward looking statements.
We will disclose in greater detail the factors that may cause such differences in the company's Form 10-Q.
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.
I would like to ask additional questions you may reenter the queue I will now turn the call over to our CEO Sumit Roy.
Thank you, Steve and welcome everyone.
We successfully executed on our strategy in the second quarter and continued to see momentum across the business.
I would like to sincerely. Thank our one team, whose focus and commitment continued to propel our business forward.
Having all of our clients and stakeholders.
We believe the strength of our platform and quality of our real estate portfolio were evident in the quarter's results.
Despite the challenging interest rate environment, if a full per share grew three 1% from last year to $1 per share.
Combined with our dividend we are pleased to have delivered a total operational return of over 8% on a trailing 12 month basis.
Delivering stable and consistent growth is foundational to our mission at Realty income.
Underlying this growth our team continues to source and invest in high quality properties at accretive spreads to our cost of capital while partnering with our clients who are leaders in non discretionary low price point and service oriented industries.
Partnering with industry leaders across over 13000 properties in a diversified real estate portfolio offers us durability of cash flows that results in the predictable nature of our revenues earnings and dividend payments.
Our investment activities remain robust as we continue to demonstrate that size and scale our unique advantages in the sale leaseback and portfolio transaction markets.
In the second quarter, we closed on approximately $3 $1 billion of high quality real estate investments, which brings our year to date investment activity to over $4 $7 billion.
Cap rates in our acquisitions appear to have stabilized after a meaningful adjustment period due a higher interest rate environment, though in select situations. We continue to find unique opportunities to source and close on larger transactions, where our relationships platform and access to capital allows us to take advantage of.
More favorable terms.
Our second quarter initial cash lease yield of six 9% represents a 120 basis point increase compared to the second quarter of 2022 and resulted in a realized investment spread of approximately 133 basis points when calculating our WAC on our left.
<unk> neutral basis, using the cost of equity and debt raised in the quarter.
In addition to closing our $1 5 billion U S convenience store acquisition from the EG group. We remained active internationally during the second quarter closing on $416 million of investments at an initial cash lease yield of seven 1%.
This international activity includes the addition of a new geographic vertical in Ireland, where we acquired two properties for $54 million at healthy cash yields.
Given the transaction velocity, we have achieved in the first half of the we are increasing our outlook for investments to over $7 billion for 2023.
Year to date, we have acquired 15% of source investment volume compared to an average of 7% over the last five years and today is more constrained environment for capital. We have found the size and scale of our platform have become increasingly meaningful differentiators as we seek accretive growth opportunities.
Shifting to operations our portfolio continues to perform and we ended the quarter with occupancy of 99% the third consecutive quarter at that level. This matches, our highest occupancy at the end of a reporting period in over 20 years.
Additionally, our rent recapture rates increased from last quarter to 103, 4% across 200 in one new and renewed leases, bringing the year to date recapture rate to 102, 7% across the 377 U or renewed leases executed in the period.
As further testament to the stability of our portfolio and the leading clients with whom we partner our client watch list declined from last quarter and now represent less than 4% of our annualized rental revenue. This is the lowest level in the last five years finally, our same store rental revenue increased two.
0.0% in the quarter, a tangible result of a purposeful decision to seek investment opportunities with higher internal growth characteristics as well as the benefit of uncapped CPI based rent escalators presently present in nearly 30% of the leases and our growing international portfolio.
Our efforts to increasingly pursue leases with meaningful contractual rent escalators has helped contribute to our portfolio with contractual rent growth at approximately one 5% per annum as off the second quarter or 2% annual growth on a levered basis.
Before turning it over to Christie I would like to recognize the tremendous value. She has brought to realty income first as a board member and then as Chief Financial Officer of leadership and counsel through a very active period for our company has left a lasting positive mark as well I would also like to.
Congratulate Jonathan on his upcoming promotion to CFO Christie.
Thank you seen that.
It's an honor to serve our colleagues board and stakeholders. During this exciting time at Realty income.
As we previously announced at the end of this year I will be retiring as CFO and passing our CFO baton to Jonathan Pong, who is our current senior Vice President head of corporate finance.
Jonathan has been with the company for the last nine years and bring significant experience to the role.
Having overseen our capital markets and Investor Relations F. P N E and derivatives function.
In his time here.
Over the last two and a half years since joining the management team. We have worked closely together as part of a planned succession and Jonathan is well positioned to carry the torch mouthing far away.
With that I would like to hand, the call over to Jonathan to go over the financial results from our quarter.
Thank you Christie I'd be remiss without acknowledging your many contributions to the company and its stakeholders. During your tenure and grateful for your guidance support and leadership all of which has laid the foundation for excellence as our business continues to bowl.
Over my nine year tenure at Realty income, we have experienced significant growth from new industry verticals geographies and property types.
However, we've continued to view a reliable growing dividend and a well capitalized balance sheet is critical components of our business.
To that end, we finished the second quarter with healthy leverage as measured by net debt to annualized.
Pro forma adjusted EBITDA of five three times and our fixed charge coverage ratio remains solid at 4.6.
Were once again active issuers of equity capital via the ATM raising approximately $2 2 billion in the aggregate during the second quarter.
$651 million of unsettled forward equity remains outstanding as of today.
As our platform has advanced and grown over time, our investment spread business has been supported by access to a wide range of products in the capital markets.
Last month, we added another capital source to our inventory raising $1 1 billion euros through our debut public offering of euro denominated unsecured bonds.
This dual tranche offering resulted in a weighted average tenor of nine years.
Average annual yield to maturity of 5.08%.
Establishing a presence in the euro unsecured bond market allowed us to diversify our fixed income investor base and generate a natural hedge for our euro denominated earnings at.
In excess of cost of debt capital that with price approximately 60 basis points inside of an indicative U S dollar bond pricing at the time of execution.
Proceeds from the offering effectively repaid short term borrowings on our multi currency revolver and commercial paper programs, which had a combined balance of $990 million at quarter end.
Combined with 274 million of cash on hand at quarter end and the 650 million afford equity previously mentioned, we believe we are well capitalized with significant liquidity.
Heading into the third quarter.
Finally from an earnings outlook perspective, the midpoint of our 2023 <unk> per share guidance is unchanged.
We are narrowing the guidance range of 396 to 401, representing approximately one 8% growth at the midpoint.
With that I would like to turn the call back over to Susan.
Thank you Jonathan.
Second quarter results illustrate our company is well positioned to provide consistent results in a variety of economic environments and to grow through a variety of different acquisition channels.
The Optionality, we have to toggle between different sources of capital is also a competitive advantage as it broadens our reach of investors and oftentimes provides a lower cost of capital alternative to the public U S dollar market.
Looking at the S&P 500 constituents within our addressable market, we count approximately 300 firms with one six trillion dollars of owned real estate.
Quantify the near term opportunity, which is available to us as sale leaseback capital providers. This group has approximately 1.2 trillion dollars of debt representing 34% of the group's outstanding debt capital maturing between 2024 and 2027.
Meanwhile, corporate bond yields have risen anywhere between 240, and 400 basis points from the 2021 average due today.
This compares to 140 basis point increase in initial cash lease yield for Realty income's investments over the same timeframe.
Making our capital solutions, even more competitively priced on a relative basis than in the past.
Because of this cost of capital convergence and because of the many benefits sale leaseback financing provides including the elimination of maturity risk. We believe there is a more compelling case to be made than ever for corporates to look to sale leaseback financing to replace maturing debt.
The attractiveness of sale leaseback financing accelerates for corporates with looming debt maturities and elevated debt costs. We believe our growth opportunities. We will continue to expand on a sustainable basis.
At this time, we can open it up for questions operator.
We will now begin the question and answer session.
I'll ask a question you May press Star then one on your telephone keypad.
If you are using a speaker phone please pick up your handset before pressing the keys.
To withdraw your question. Please press Star then two.
At this time, we will pause momentarily to assemble the roster.
And our first question will come from Nate Crossett of BNP Paribas. Please go ahead.
Hey, good afternoon, and congrats Dr Jonathan and Kristi.
Maybe just a question on guidance, maybe you can just unpack.
You guys increased acquisition volume guidance.
At the midpoint.
And I ask that all of them in the same maybe you can just kind of go over the puts and takes there.
And then also what are you guys assuming for kind of cap rate in your guidance.
I think we're down 10 basis points in the quarter.
It's kind of the outlook or the pipeline right now.
Tonight I'll take your second question first and then I'll hand, it off to Jonathan to talk about puts and takes are with regards to the earnings guidance.
With regards to the cap rate, we're assuming the cap rate to be within the ZIP code that we've announced in the second quarter and in the first quarter, that's where we believe where the cap rates have settled down opportunistically. There are situations that we could enter into where we could drive those cap rates higher.
But for modeling purposes, I would request.
We request that you keep it within the ZIP codes that we've announced in the first and second quarter.
Jonathan.
Hey, Nate on the guidance question I would first of all let's say the midpoint of our guide isn't statements only one part of the year and so you know when you think about how we put guidance together. There is a lot of puts and takes that we look at at the beginning of the year revisit that every quarter.
We know that on a probability weighted basis not all of the it takes are going to happen in all of what's likely to happen and so when you think about.
Acquisition guidance, increasing two quarters now.
That was a scenario that we had expected at the start of the year, but there was always going to be.
Puts and takes that could offset that that I think the biggest one for US has been short term interest rates. When you look at what was implied back in January February .
So for Ford curve, you compare that to what it's implying today.
40 basis point increase and so that alone any per share bar business and the <unk>.
Back half of the year, So I would say that and there's also some other things that are.
We always look at that maybe we're taking a slightly more conservative view on the second half of the year appropriately.
We feel very good about being more accurate from what we came out for the year.
Yeah.
Okay. That's helpful. Maybe just one on the debt rates are much lower in Europe , you did that recent bond deal.
Can you just like talk about how much you could kind of theoretically raise over there to kind of take advantage of the better cost of capital.
Are there any like hindrances like in terms of size.
Yeah, no we're not going to go.
Crazy and have <unk>.
Significantly more liabilities.
The nominated and won currency relative to the assets we have the normally in that same currency, especially when it's foreign denominated.
And so you know for us when we're going out and issuing in various currencies. We're thinking about the income statement FX risks that we might have that are using.
The natural interest expense in that currency to serve as a hedge if we don't have that theres not a lot of reason for us to go out and do that type of issuance. We also know that we have a very active acquisition pipeline across all currencies. We know that we're going to need capital at some point really denominated in dollar sterling or euro so.
That's how we think about it it was a 60 basis point pick up relative to comparable U S. Dollar.
But for US, it's really about diversification and so you can expect us to utilize everything our toolkit going forward.
But I think we are all set on the euro side at least for the near term.
Yeah.
The next question comes from Greg Greg Mcginniss Scotiabank. Please go ahead.
Yeah.
Hey, good afternoon.
As always I'm interested in any larger portfolio deals and we appreciate your opening remarks regarding the size of the potentially addressable S&P 500 market, but if you've noticed any material uptick in sale leaseback interest from those companies at this point or is that still a you know a.
Developing.
<unk>.
I guess, we have to post one of these large transactions per quarter and I think we've done that.
If you look at what we've done in the fourth quarter of last year.
That's when we closed on the gaming asset, which was $1 7 billion you look at the large portfolio deal. We did in the first quarter. It was the CIM transaction that was circa 900 million.
And.
In the second quarter, we've announced the $1 5 billion and closed the $1 5 billion EG group transaction.
And look the reason why we are sharing all of this data to help support what we are seeing developed in our pipeline.
And the conversations that we're having currently now how much of that gets translated to close transactions time will tell but clearly we are very optimistic and that is one of the main drivers of why we have increased our guidance by another $1 billion in terms of acquisitions. So.
We just feel like you know I I wish our cost of capital was slightly better but in terms of actual transactions well, we feel like the pipeline is robust and it's largely a function of what is happening in the debt capital market.
Okay, what about what are your thoughts on increasing maybe the level of tenant debt investments to push earnings growth higher and and no offset some of that cost of capital, it's not exactly where you want it.
Well you know, we think of ourselves as an investment company and Greg So where do we invest on the capital stock is is always available for debate within the four walls of Realty income and.
Wherever we feel like you know we can quantify the the the risk.
And you know underwrite the benefits of doing a sale leaseback versus doing a direct are known to one of our clients are we are going to go down the path of whichever yields the best risk adjusted return. So yes, we haven't done one of those but it is certainly up for discussion.
And it's one that we have been discussing with with with my colleagues here at Realty income.
The next question comes from Brad Heffern of RBC capital markets. Please go ahead.
Yeah. Thank you operator, hey, everybody.
But can you give your updated thoughts on how you feel about the theater business broadly right now obviously AMC recently reported its first week, but then you have the strikes, which theoretically start affecting things at some point in the release schedule yet isn't back to normal. So are you feeling worse at this point or better given the recent strength.
Yeah, So Brad I I, you know I've always stated this about the that she had a business that is largely a function of content and as long as the content continues to develop and it goes back to levels that it was pre pandemic, which was circa 70 75 big 10 type.
The releases, we're going to get back to you know level, it's pretty close to the revenue levels that we had in 2019.
And anytime you have situations like the one that you've just described where you have a strike you know it does obviously put a little bit of a break or in terms of the ability of studios to continue to release.
Those big tent movies, the good news in today's environment versus the last time, there was a strike which lasted if I remember correctly from for about four months.
The good news today is we've got a lot more studios are beyond the big four that are releasing big budget movies, and I'd put Amazon and Netflix and the mix there.
But yeah, all else being equal a strike is not a good thing why see this having a near term impact I don't think so because a lot of these movies have already.
Being completed and it's just a question of staging the release, but longer term it could have a disruption on how many of these movies get released and and and so we are watching this closely I believe theres a meeting on Friday.
Where the studios are getting together with the writers and the actors and on all of that and my hope is that there is a resolution soon and but yes. It is it is a situation that we're monitoring closely but my expectation. If it has any anything like what it was last time. This should resolve itself in the next couple of months.
Okay. I appreciate that and then can you give your expectations for the center World sites that were rejected and maybe talk through some of the opportunities with those whether it's just typical releasing or if there's a development opportunity for any of them.
Yeah, So Brad I'm not going to give.
Go into the details of the Cineworld situation, just because we haven't quite.
And though the contract yet what.
What I will say is that any of the potential economic outcomes have been completely reflected in our updated our earnings guidance.
So you know that's how I'm going to leave it with with the <unk> situation.
Hum.
I'll, just add something to stop that I've already talked about in the past there will be a few assets that we expect to get back and we have already started to look at you know what are the alternatives are at those particular, you know our sites.
And the gamut runs from you know a complete redevelopment of the site to an alternative use I E. Industrial two situations, where we have a retailer coming in and talking about potentially just taking the asset as is.
Even though theyre not movie theater operators.
To potentially re.
Entitling the asset for an alternative use and selling it I E, creating more value for ourselves.
And and the last bucket will be just selling the asset as is.
So all of those various permutations are being considered on the handful of assets that we expect will get rejected through this process, but I'm not going to go into any more detail than that.
The next question comes from Handel St. Juste of Mizuho. Please go ahead.
Hey, I guess its still good morning out there first of all congratulations again to Jonathan into Christie.
Certainly I'd like to go back to a conversation we've had in the past on high grade.
You continue to source deals here with a lower share of high grade than historically.
And I know in the past you've talked about that you experienced in acquiring higher yielding assets and your focus on generating the best risk adjusted returns.
But this quarter, particularly we had a big drop but it continues a trend of having below average I great. So I guess is this a dynamic that we should just expect to continue going forward as the new norm, how should we think about the share of high grade going forward. Thank you.
Sure. Thank you for that question Handel.
So just to continue to reiterate the point, we are not targeting investment grade.
What are you targeting our opportunities that yield the best risk adjusted return if it so happens that it is an investment grade client and so be it but ultimately it's the economic profile of that investment that's going to dictate as to whether or not we're going to invest.
Today truth be told.
You know we're looking at some of these investment get great opportunities and cannot.
So the risk adjusted returns we are finding far more value in areas, where we're looking at sub investment grade tenants, we're willing to give us a return profile that is commensurate with the inherent risk in that particular opportunity.
And that's what's driving the you know the approximately 26% year to date.
<unk> grade closings that we've done and it's closer to 18% I think for the for the second quarter.
But that's how we that's how we think about the world.
The other thing I'd just point out is you know just to make it equivalent because I have seen some of these cap rates being reported and there's a bit of a mixed match.
When we're talking about a six 9% cash lease yield.
If you layer in the straight line, we're talking about an additional 100 basis points and I've seen certain reports that that are sort of conflating. These two numbers.
So just to make it apples to apples are straight line yields are.
Closer to seven 9% on $3 $1 billion worth of acquisitions.
That's where we are seeing the value, which I would argue much better growth profile.
And clearly that's represented in the 100 basis points of increase when compared to cash yields. So that's that's how you should think about us handle.
And if it just so happens that this dynamic were to shift and suddenly investment grade was to go back to our 40%, 45% that we have in our portfolio.
Then that'll be it but it's not it's not something that we target and.
You Shouldnt expect us to be targeting that number going forward.
That's really helpful. I appreciate the color there.
And one more I guess wanted to get your updated thoughts on investing in gaming assets today I know in the past you've talked about having an interest I'm curious if you're seeing anything out there today that would interest you what type of return to incremental spreads.
Spreads you require there and specifically your potential or your level of interest and potential bellagio trade. Thank you.
Sure. So again I'm not going to talk about specifics, but I'll repeat what I've said in the past about our desire to grow our gaming vertical.
You know we are obviously looking at many opportunities and thankfully, it's a fairly robust environment today for gaming.
And yes in terms of how are we going to view these opportunities.
It's along the lines of how I answered the previous question.
So that's what you should expect from us for this particular vertical.
Yeah.
The next question comes from Joshua <unk> of Bank of America. Please go ahead.
Yeah, Hey, guys. Thanks for the time.
I saw your cap rates on most.
Domestic acquisitions.
And then for developments there was like a six nine.
And it kind of basis point spread seems kind of small.
A function of kind of when deals are struck or just the risk profile of the tenants or do something thats.
Probably in the market.
Yeah very good question Joshua as you know you know when you enter into transactions that have a long duration associated with it which is what development by its very definition is going to have.
It does become a function of when will those transactions entered into.
And and and you know, what's the duration of that build out period and so what you might have noticed is.
If you're if you're tracking our development yields over the last few quarters, you've noticed a marked increase in those cash yields on developments. It is largely a function of when did we strike those so things that youre starting to see filter through in the second quarter, which has a similar.
To what you saw on the on the domestic side.
Largely a function of us having entered into those transactions over the last two to three quarters. When we were anticipating a much higher interest rate environment, and therefore being able to work with our clients to get that <unk> reflected in the development cycle and you should continue to see that you know trends slightly high.
Hum.
You know looking into the next few quarters.
As some of the older.
You know generation development opportunities start to sort of.
Get fully developed in or are you now.
Become cash paying opportunities. So I think just keep a close eye on that and Thats. The trend you should you should see manifest itself over the next few quarters.
Okay, alright that makes sense.
And then I think Jonathan might have answered this but just wanted to clarify that top end of guidance.
Took down two cents.
Was it just the interest rate environment, that's pushing that put.
Put downward pressure on that top range or anything else and I was just curious given bumped our acquisition guidance.
Okay. So.
Hey, Hey, Josh.
Trust that Sumit brought it up earlier of the impact.
What we felt was the greatest uncertainty.
Resolution of that impact now.
Sure.
Going into the quarter.
Something where there was a range of possibilities that we built into the high end and the low end and sell with a greater sense of confidence now where that's trending we felt that it was appropriate to take the high end down by <unk>. In addition to bringing the low end up by two.
Okay.
The next question comes from Michael Goldsmith of UBS. Please go ahead.
Good afternoon. Thanks, a lot for taking my question, Jonathan you've been with Realty income for a while and I think youre developing reputation for creating solutions from a financing perspective, but as you move into the CFO seat is there anything different to you.
Is there anything different that you would think about doing in their new position.
Or different approaches to two to what royalty is doing overall.
Thanks, Michael I. Appreciate the question I would say look what's the Meda Realty income so successful over the years, regardless of what we've done what verticals we've established that.
Our commitment to.
Our fortress balance sheet.
And that's the one thing that is going to be sacrosanct to us.
For yeah.
Long as you know were in existence in D C.
And so we're not going to sacrifice things like the <unk> III minus credit rating that we worked very hard to get were not going to sacrifice.
Russell fixed income community that now spans.
Across three of the currencies and so youre going to see us continue to focus on the leverage.
Plenty of liquidity.
We're going to be very predictable from from that standpoint.
Going forward given the added complexity of the business the volume the transaction volume that we see the different countries that we're in and we will continue to be and I think it's really more of a focus on more of an internal operations, though the <unk>.
External side of things I think we're pretty well established were going to continue to be creative.
But I think it's about mobility can continuing this momentum on the internal platform.
We've created which we think is a differentiator.
And the net lease industry and frankly in the real estate industry.
Okay.
Thanks for that and assume it.
You mentioned your size and scale as a competitive advantage at least twice if not three times on the call.
You feel like do you feel like your competitive advantage is growing are you seeing fewer bidders on some of the larger deals out there.
Is that gap and the strength of the size and scale is that is that improving and widening versus.
Versus peers.
Yeah.
Thanks for the question, Michael I might have actually said it four times I'm not sure.
I just believe in it so much and it's really not something that we believe it's what we are hearing when we are engaging in these conversations with clients who are big clients, who have big questions that theyre trying to answer.
It's the fact that who gets invited to the table.
And when we see that we are the only REIT in the net lease space at the table competing against private sources of capital that in itself gives us continued confidence that we are playing our game.
That is.
It's very different from some of our smaller peers.
And and and.
And we want to be that we want to be the real estate partners of choice for the S&P 500 names, we want to be the first name that is considered when we win when folks think about they have the ability to write big checks. They have the ability to stand by what it is they say their reputation.
<unk> four itself and their ability to close is bar none.
And and and when we hear those comments from clients, who work with us and more recently with some of our new clients who have.
Being added to our registry.
It gives us continued confidence to say that our scale and size.
You know is being appreciated within this space.
The next question comes from Eric Wolfe of Citi. Please go ahead.
Thanks, just wanted to follow up on Greg's question.
When you look at your S&P peers, just curious what percentage would you say are receptive to the sale leaseback conversation.
How has that changed versus a couple years ago.
Just trying to understand how your addressable market is changing and so does that perhaps arent as receptive what's the typical pushback.
I can give you percentages, Eric but what I can point to is just look at some of the larger transactions, we've done and who have to be done it with.
And they're all first time sale leaseback candidates right.
Think about wind.
They were they've never done a sale leaseback before and they chose to do it with US think about EG group, they've never done a sale leaseback before their best chance of doing a sale leaseback was when they actually.
Ended up being the winners on the Cumberland farms portfolio. This was three or four years ago and they chose not to do it at that time.
And so you know part of the reason why I believe that sale leaseback as a product is maturing is certainly driven by the capital markets environment that we find ourselves in and suddenly finding that sale leaseback.
As an alternative to raise capital.
Is quite beneficial vis vis competitors being as we were traditionally being compared to the debt capital markets, especially for names that are you know.
Lower investment grade or sub investment grade.
Candidates.
And so I I believe that that will continue.
And there will be other transactions that we hope to get over the finish line that we can speak to.
That will again be you.
First time candidates and.
Yes.
We feel like that that will continue to grow.
That's helpful. And then you look at the 10 year or whatever interest rate you want to look at it and it's up pretty meaningfully over the last couple of weeks when you see moves like this.
How quickly will you adjust your pricing on future acquisitions or potentially even retreated recent deals just trying to understand how sort of real time capital market volatility.
Volatility.
Changes of return helpless.
Yeah, So Eric I'm going to have.
Jonathan talk a little bit about things that we try to do to anticipate.
What I'll call.
You know.
And anticipated movements in 10 years okay.
We can talk about our hedge.
Hedging strategy that we have in place.
But I just want to make one point very clear you know our cost of capital gets mark to market pretty much by the second.
That's not how cap rates move there.
There is absolutely a lag time, how sticky these movements these upward movements in the cost of capital.
The people have a different opinion about how sticky that is and that drives their view around you know what cap rates should be and it does take time for people to adjust.
To a to a higher cost of capital environment, and if theres a lot of volatility that makes that adjustment period that much more difficult.
So you know, yes, we've seen movements in the on the 10 year from 386 to $41 7418 today within a matter of days, you're not going to see a 30 basis point movement in cap rates to reflect this movement in 10 years, unless we see that this 474 point.
For $1 seven God forbid for 74174 point to become a more sustainable rate.
But then what do we do from a balance sheet perspective to sort of anticipate those situations I'll have jonathan speak to that.
Thanks Sumit.
<unk> been very active on the hedging front paws, or FX, which I alluded to earlier, but also on the interest rate part.
Got you.
Look at the 10-Q from the first quarter, you'll see that we actually.
Purchase.
Swaption.
Which really go out until January of next year that protects us against rising rates on the tender.
The reason why we chose a volume of eastern YY to January because we do have some debt maturities coming up of around $1 billion. One in the first quarter of last year, we put those hedges in place.
In late March early April and sizes by the imagine.
Pretty healthily in the money right now.
So from that standpoint, we've taken out.
The primary balance sheet.
Or refi risk that we have.
Yes.
Six to nine months, but.
We're always going to look for opportunities, where we see a risk we want to be proactive.
But what we can do is mitigate the exposure that we have.
Potential risks itself, yes, that's something that we've done now twice and we'll of course homelink what it was in the middle of a pandemic and.
Are you going to monetize that.
Forward starting swap.
The $72 million gain will not always going to be so fortunate but.
Our thinking about managing.
Yeah.
The next question comes from Wes Golladay of Baird. Please go ahead.
Yeah.
Hi, everyone can you talk about what's going on in the U K. It looks like volume was low I'm. Just curious if this is a function of just low deal volume or is it just pricing just wagging still over there.
Yeah.
<unk> needs to work a little bit harder I think.
It really is a timing issue as.
You know we had some great momentum towards the end of last year, driven by pressures that funds were experiencing on the redemption side and it created some amazing opportunities for us.
That momentum continued into our into the first quarter.
Second quarter was still very healthy we did about $420 million, which is a big number but it's just you've got dominated by what we did on the U S side, largely driven by the $1 5 billion. If you take that $1 5 billion away and you look at what we've done we were at one six.
Billion of which the the.
European International business represented I would say trying to do quick math right around 30%, So and that's generally been where you know the the international businesses contributed but no.
Look I'm I'm very excited about that business.
And you know there's more to come.
Okay. It sounds good yeah, good job Neal that's actually a good volume was adjusted I guess next question as more and more bigger picture.
I'm kind of curious what your opinion would be what is the bigger risk to turn that lease would it be inflation and potentially having this price escalators were to be tenant credit at this point in the cycle.
I would think it's a tenant credit you know you will.
<unk> have to look at all of the various different net lease businesses.
And take a view on where do you see the credit risk largely driven by these inflationary pressures the persistence of those inflationary pressures, which then obviously is resulting in this higher interest rate environment.
I think that's going to sort of filter through.
And it will impact net lease businesses net lease companies differently, depending on the makeup of where their exposure lies.
For me you know one of the advantages that we have is do we can be perfectly match.
You know inflation with the inherent growth rates that we have we can't so there's always going to be a bit of a mismatch, but halfway and now I'm talking about realty income done a much better job of growing the inherent growth profile of our leases. The answer there is a categorical yes today.
But I think it was part of my prepared remarks.
Our overall portfolio. If you were to do nothing will grow by one 5% and on a levered basis closer to 2%. Some of it is actually benefited from non cap CP is that we've been able to get on one third.
Of the assets that have CPI growth rates built into them in the international markets and those have contributed greatly to increasing our.
You know, our our inherent growth rate.
So.
It's never going to be perfectly match, but the but the risk of not having a perfectly matched growth rate inherent in your in your leases is somewhat muted versus credit risks that could.
Translate into much bigger.
Impact on your overall business.
The next question comes from Ronald Camden of Morgan Stanley . Please go ahead.
Hey, just two quick one staying on the tenant.
<unk> credit risk and so on so I see occupancy 99 median EBITDAR it looks like it ticked up two eight versus 2.7 last quarter and I know that you reported with a lag, but still pretty interesting and I think in your opening comments you mentioned that basically the watches because this was the lowest sort of ever. So so so things are strong.
Selling pretty good but as you sort of look look for a while.
You hear stuff like you know student loan starting again.
Our property insurance in Florida, just sort of curious how does your team sort of stress test that or think about that what the potential impact could have.
On the tenant side. Thanks.
Yeah. Good question Ronald and just to just to clarify it was in the last five years that I said that our credit watch list as you know in the threes. It's the lowest it's been in the last five years.
Those are very good questions you know what is it when students lows loans get instituted back again and discretionary income fault what are the first things to go.
Going to be discretionary spend right.
And if you look at the portfolio that we've created that.
Largely consists of a non discretionary low price point service oriented businesses. These are things that will be the last to go could they be impacted of course they can.
But when you have discretionary income that is getting compressed those are not going to be the types of businesses that will get impacted first and that's how we've.
Hum.
Constituted our portfolio of assets.
It is being very much focused on what are the industries that are going to be a lot more resilient on the economic conditions like the one that we are facing today.
So it is not by by you know by luck that we find ourselves with a credit watch list that is circa three 7%. It is by design.
And you know and that's how we run our business Ronald.
Great and then my second one was just so.
So going back to guidance a little bit.
Taking a step back thinking about this year, just what are the sort of the big two or three sort of comp issue that that that the guidance is facing this year I think you hit on one which is the interest cost.
Sort of headwind right for this year, but presumably that's all going to be an issue for 24, because the comps just as not as tough but was there anything else sort of one timey or unique to this year. It could be property tax you know it could be whatever that we should be mindful for 'twenty three that maybe does not sort of.
And again in 'twenty four.
Hey, Ron it's Jonathan I'll say I'll expand on what I said earlier regarding short term rates we.
We talked about the impact to the back half of this year, but when you really zoom out and you look at year over year.
Versus all of 2022.
2023.
Now, it's even a greater impact that's closer to seven or eight.
Based off of the midpoint of our guide is about 2%.
So you take that out and you know on a normalized basis the volume that we're doing everything that we're doing.
Portfolio of asset management standpoint, we're trending closer.
Two a 5% number year over year, if we were at three 1% this quarter.
The first quarter did have a little bit.
I'll have a tougher comp if you recall in the first quarter of 2022, we did have a significant reserve reversal in theater industry.
So that's why the first quarter was a little bit flat second quarter.
Outside of rates are is getting back more towards a normalized level. So back half of the year I think youll continue to see some difficult comps on the social front and given that we do have even at 8%, 10% exposure to variable rates.
Just given the magnitude of the move that's that'd be the biggest driver.
The next question comes from Linda Tsai of Jefferies. Please go ahead.
Hi, Christie Sad to see you go you have great perspective, and Jonathan well deserved congratulations to you both.
Just going back to your comment regarding the stickiness of cap rates the investment spread of 133 basis points, how does that vary between international and domestic investments and where would you see investment spreads in those two categories trending.
Yeah, if you're if you're actually followed the.
The headline cat cap rates that we are registering I think the international business was 20 basis points higher.
So that should answer your question Linda.
But again this is going to be very much a product by product opportunity by opportunity discussion in terms of what is the actual spread that we're going to realize and is there an advantage.
Between the domestic markets in the international markets.
The advantages are very different.
Sure in the U S market, there's clearly more competition there are more players in the international markets, we don't experience that.
The U S market. However is a much more mature sale leaseback market and so there are more opportunities that one can participate and whereas I would say the international market is still in the nascent stages of sale leaseback as a viable product. It is maturing but it is it is behind the curve and.
And for US what we want to try to do is position ourselves in both these markets and work from you know are our.
Points of strength that that allows us to then when transactions.
Our average has been 150 basis points of spread from the time, we've been tracking.
Spreads.
And our first quarter it was 200 basis points.
Based on realized.
You know capital that we raised to actually help finance our business. This quarter based on again the same method, it's 133 basis points. So if you average out you know.
To date, it's still north of what our 150 basis points historical average has been.
But it's very difficult Linda to.
To tell you you know going forward youre going to have one geography that is going to dominate.
You know the spread.
Versus another it's very much opportunity driven.
Got it and then I think you said, 30% of your international leases have uncapped CPI.
Is the nature of those tenants that are open to that versus the other 70% of leases that don't have uncapped.
Yes, Linda let me be a bit more precise.
Off the international leases that have CPI as the driver of internal growth.
Third or 30% of them are uncapped.
So not all of our leases and the international markets have CPI drivers of internal growth.
So I just wanted to make that.
Verification.
And again it is it is very much a function of the market you know.
A market that is used to seeing CPI growth as the metric you know form in their leases. They are far more receptive to continuing to see that now there has been some pushback given just the sheer magnitude of inflation that's being experienced in some of these markets and we are trying.
To be commercial about that.
But.
You know, it's very difficult suddenly to go to you know a client here, who happens to be an investment grade client and say sorry, we won't CPI growth, you're not going to get that so.
Yeah, we see we tend to see more uncapped CPI growth in the international markets than we do here and.
Yeah, but that too is evolving.
The next question comes from harsh Kumar of Green Street. Please go out.
Thank you.
You mentioned that in the past or sourcing.
What do you close this roughly 7% of what you source and this quarter was closer to 15% do you worry at all of the net lease transaction market sort of continues to remain in liquid.
And actually royalty income Youre closing $5 billion to $7 billion annually.
Might not have the luxury to be as selective as you would in the past and maybe you have to execute on your second or third best idea. How are you thinking about that looking over the next 12 months.
Well the good news here shows that we haven't gone to executing on our second or third best ideas yet.
We're very fortunate.
Let me let me.
Shed some light on this 15% closing rather than what we've traditionally done which is the 7% to 10%.
What is skewing. This is clearly the $1 5 billion dollar transaction that we closed on in the second quarter, but it's not reflected in the denominator and the sourcing volume of $15 billion. We had sourced that asset I would say probably in the fourth quarter of last year.
So that's where the mismatch occurs in.
In some ways the sort.
<unk> volume is much more real time, what did we see.
And you know there is generally a lag between when we engage in a conversation I E. When it is sourced versus when does that particular transaction get over the finish line of closes and I think that lag. Sometimes you know does create this mismatch. So if we were to sort of take away the 1.5.
And then look at the $1 6 billion that we ended up closing.
Yeah, you know.
In a quarter, where we re source 15 $16 billion that is still 10% so.
I think that that's probably the way to think about this mismatch that we saw in the second.
Second quarter.
Okay that helps.
Oh, and then the one six trillion stack you've provided that there is one six trillion.
Commercial real estate on S&P 500 company balance sheets, how much of that is is real estate that you would actually want to have in your portfolio. So I imagine you don't you're not actively.
Really acquiring office assets.
Could you share how much of that is maybe detailed gaming et cetera that you might go up.
Yeah, that's a great question harsh and we did that when we talk about <unk> four trillion here in the U S and eight trillion in Europe .
And just to be ultra Super clear about this particular statistics that we shed.
In the prepared remarks. It does not include other real estate companies. It does not include certain sectors like finance companies banks.
Energy companies et cetera, et cetera. These are operating businesses that have assets.
And an easy way to think about it is you know, let's assume that half of it is office, let's assume that another 20% of it is something that we wouldn't want even if it is 20% or 30% of this one six trillion that is a massive number.
And the point is that these are companies that are going to have to refinance that debt. This 1.2 trillion dollars of debt over the next three years, it's maturing over the next three years and sale leaseback should be a conversation that is.
Appealing to them, especially given the cost of doing a sale leaseback today in this environment versus the cost of refinancing that a lot of these companies are going to experience that's really the point.
This concludes our question and answer session I would like to turn the conference back over to summit Hooray for any closing remarks.
Thank you all for joining US today, we're looking forward to seeing many of you at the various conferences this fall.
Good rest of your summer Bye bye.
The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.
Okay.
Yes.
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