Q3 2024 Realty Income Corp Earnings Call
Good day and welcome to the Rilty in some third quarter of 2024 earning Johnson's call.
All participants will be in the snowy mode.
Chuginated Systems: Chuginated Systems, Police Signal Conference Specialists, my pressing the star key followed by Z-Row. After today's presentation, there will be an opportunity to ask questions. You may press star, then one on your touchdown phone. Two would draw your question, please press star, then two.
Please note this event is being recorded.
Speaker Change: I would now like to turn a conference over to Kelsey Mueller by his president and best relations. Please go ahead.
Kelsey Mueller: Thank you all for joining us today for RealCNCum's third-quarter operating results conference calls. Discussing our results will be Sumit Roy, President and Chief Executive Officer and Jonathan Pong, Chief Financial Officer and Treasurer.
Speaker Change: During this conference call, we will make statements that may be considered forward-looking statements under federal securities law. The company's actual future result may differ significantly from the matter discussed in any forward-looking statements.
We will disclose in greater detail the factors that may cause such differences in the company's form 10Q.
Speaker Change: 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.
Sumit Roy: Thank you, Kelsey. Welcome, everyone. Realty Income's third quarter results highlight our continued momentum, disciplined execution, and the benefits of our global investment and operating platform.
Sumit Roy: Our value proposition to investors is simple, a real estate partner to the world's leading companies. We've created a defensive and diversified real estate portfolio consisting of top-tier clients to drive stable and predictable cash flow.
Speaker Change: As a result, we've delivered positive total operational returns each year since becoming a public company 30 years ago, successfully navigating a variety of economic environments.
Speaker Change: Importantly, as we move through an improving external backdrop, helped by a recent rate cut in the US, we've started to see a more attractive transaction landscape.
Speaker Change: Given this, we are pleased to increase our 2024 investment volume guidance to approximately $3.5 billion, underpinned by strong investment activity year-to-date, as well as a robust pipeline for the fourth quarter.
Speaker Change: And currently, we are raising the low-end of our AFL-4-Per-Share guidance for the year to a range of $4.17 to $4.21.
Sumit Roy: Despite some recent volatility driven by exogenous factors,
Speaker Change: We remain confident in our strategic vision and the opportunity ahead. Our investment strategy offers significant opportunities for growth across multiple verticals.
Speaker Change: including our core of retail and industrial and newer verticals such as data centers and gaming. At the same time we are making progress towards the establishment of a private capital fund which I'll touch on later in this call.
Speaker Change: Turning to the details of the third quarter, we delivered AFFO per share of $1.05, representing a 2.9% growth compared to last year. We invested $740 million into high-quality opportunities at a blended 7.4% initial cash yield or a 7.8% straight-line yield, assuming CPI growth of 2%.
Speaker Change: Of this, $378 million of volume was invested in the U.S. at a 7.4% initial cash yield, with a balance of $362 million invested in Europe at a 7.3% initial cash yield.
Speaker Change: We've seen meaningful improvements in both the U.S. and Europe. Our international markets continue to contribute a greater share of volume relative to prior years with healthy investment activity year-to-date, exemplifying the benefits we achieve by cultivating multiple avenues for growth.
Speaker Change: In total, we completed 70 discrete transactions, including four transactions over $50 million, which represented nearly 60% of our investment volume, highlighting the breadth of our platform.
Speaker Change: As I noted, the momentum we are seeing in the transaction market supports increase to this year's investment volume guidance to $3.5 billion.
In the third quarter, our organic acquisition activity, which excludes credit investments as well as development spending largely negotiated in prior quarters,
Speaker Change: totaled $594 million, or more than double the second quarter's volume.
Speaker Change: We expect further momentum through the balance of the year, with an implied fourth quarter outlook of approximately $1.3 billion in investments, which is fully funded as we are vigilantly focused on deploying capital into high-quality opportunities that meet our risk-adjusted return requirements.
Speaker Change: Capital deployed in the third quarter yielded an investment spread of 243 basis points, above our historical average spread of 150 basis points.
Speaker Change: This spread was supported by $165 million of adjusted fee cash flow available after dividend payments to fund investments.
These spreads are based on our short-term nominal cost of capital that measures the year-one dilution from utilizing external capital and excess free cash flow on a leverage-neutral basis to fund our investment volume.
Speaker Change: As a reminder, our ultimate investment decisions are based on our long-term weighted average cost of capital, which burdens every dollar of equity with the same cost of equity.
Speaker Change: underpinning our increased investment activity, the external capital improved
Speaker Change: by approximately 65 basis points in the third quarter.
Speaker Change: This compares to the decline in our weighted average initial cash yields of approximately 50 basis points during the quarter.
Turning to Portfolio Operations.
Speaker Change: We've created a diversified portfolio of more than 15,400 properties with high quality clients that have proven resilient through various economic cycles and continue to deliver stable returns.
Speaker Change: In addition, our vast data availability, proprietary predictive analytic tools, and insights of our asset management and research teams enhance our ability to anticipate future trends.
Speaker Change: We finished the quarter with 98.7% occupancy, a 10 basis point decrease from the prior quarter.
Speaker Change: Our rent recapture rate on the 170 leases we renewed was 105%, totaling approximately $38 million in new annualized cash rent, thanks to the diligent efforts of our team.
Speaker Change: Separately, we are continuing to lean into dispositions as an additional source of capital. In the third quarter, we sold 92 properties for total net proceeds of $249 million, of which $87 million was related to vacant properties.
Speaker Change: This brings our year-to-date total to $451 million. For the year, we now expect proceeds of $550 million to $600 million on asset sales. With that, I'd like to turn it over to Jonathan to discuss our third quarter financial results in more detail.
Jonathan: Thank you, Sumit. We are pleased to deliver another strong quarter while increasing our investment in AFFO guidance for the year, reflecting continued momentum.
Speaker Change: Consistent with our investment strategy, we remain disciplined in our balance sheet management.
Jonathan Pong: Our strong balance sheet, underscored by A3, A- credit ratings, and deep access to capital globally continue to represent significant competitive advantages, fueling the opportunity to grow earnings through multiple channels.
Jonathan Pong: Our leverage, as measured by NetDebt's annualized pro forma adjusted EBITDA, was a healthy 5.4 times what was in our target ratio, or 5.2 times, including $969 million of unsettled forward equity outstanding as of today.
Speaker Change: Our fixed charge coverage ratio of 4.6 times remains in line with the 4.5 to 4.7x range we have delivered consistently over the last seven quarters. Our focus on de-risking our future funding needs was a catalyst behind our two bond offerings during the third quarter.
Speaker Change: which consisted of a $500 million, 30-year U.S. dollar bond offering and an effective semi-annual yield to maturity of 5.49%.
Speaker Change: and a dual-traunch sterling bond offering that raised 700 million pounds at a weighted average tenor of 11.1 years and a weighted average annual yield and maturity of 5.4%.
Speaker Change: These offerings illustrate the diversity of debt products available to us and the intentionality of our capital diversification philosophy.
Speaker Change: Our 30-year offering was our first 30-year issuance since 2017, and our public sterling offering was our fifth non-U.S. public bond offering in approximately three years, bringing our foreign-denominated outstanding unsecured debt to over $8 billion.
We are grateful for the loyal support we have received from the fixed income community as we continue to expand our credit presence globally.
Speaker Change: At quarter end, we held $5.2 billion of liquidity, including unsettled forward equity, in addition to retaining a most full-capacity net of cash available on our $4.25 billion revolving credit facility.
Speaker Change: Only 3.4% of our outstanding debt at the end of the quarter was variable rate in nature.
Speaker Change: illustrating the financing flexibility we have heading into the end of the year.
Speaker Change: Access to capital is paramount to the success of our company, and our portfolio size, scale, diversification, and our trading liquidity in the public markets have consistently afforded us well-priced capital to grow through large-scale high-quality investment opportunities.
Speaker Change: With that said, we strive to demonstrate a proactive, forward-looking mindset as we plan, position, and evolve our financing strategy for future growth.
Speaker Change: Over the last few years, we have evaluated additional sources of equity capital beyond the public markets and have recently begun, in earnest,
Speaker Change: to build a private capital infrastructure that we believe, over time,
Speaker Change: will leverage our strengths and expand the breadth of our capital allocation opportunities globally.
Speaker Change: Thank you, Jonathan.
Speaker Change: As we mentioned last year, a natural step in our evolution is to diversify and enlarge our access to equity capital through private markets.
Speaker Change: We see multiple strategic benefits of entering the private capital business.
Speaker Change: First, the amount of equity available from private sources far exceeds that which is available through the public markets we have traditionally accessed.
Speaker Change: The size of the U.S. private real estate market is approximately $18.8 trillion, ten times larger than the $1.9 trillion of assets owned by public REITs.
Speaker Change: Thus, private capital controls more than 90% of the U.S. commercial real estate market based on research from the National Association of Real Estate Investment Trusts.
Speaker Change: The creation of a private capital investment platform is expected to provide us with access to a deep pool of institutional capital from investors who may otherwise lack the mandate or ability to invest in real estate securities.
Speaker Change: Second, access to the alternative source of equity with generally less pricing volatility will give us the opportunity to accelerate the monetization of the scalable and proven investment and operating platform we have built, in turn, supporting our ability to continue delivering value to shareholders.
Speaker Change: Third, a powerful element of the fund management strategy is the incremental capital light fee earnings it's anticipated to offer.
Speaker Change: Base management income earned by managing third-party capital represents a source of recurring and potentially high growth revenue which we observe as receiving a premium multiple from the investment community.
Speaker Change: The vast majority of fees earned would be recurring in nature and generated through open-end perpetual life funds rather than performance-based or transaction-oriented fees.
Speaker Change: Fourth, the scalability of our differentiated business model will allow us to advance this initiative with limited incremental investment while leveraging the collective talent and experience of our top-tier team and platform.
Speaker Change: Leveraging that history, we have harnessed an impressive quantum of property level data to develop our proprietary predictive analytics model to support decision-making. With additional size and scale, these data driven insights will become increasingly robust and accurate.
Speaker Change: Together with the expertise of our team, we believe we provide a compelling co-investing platform for investors.
Speaker Change: Finally, we believe private capital will enable us to source, acquire, and manage a large percentage of available market opportunities that we currently acquire for the public vehicle.
Speaker Change: Overall, our intent is to create and operate an evergreen, open-end fund that will manage private capital on behalf of institutional investors such as pension funds, sovereign wealth funds, endowments, foundations, and large insurance companies.
Speaker Change: To be clear, this structure will be distinct from a typical private equity-style closed-end fund that may have a fixed duration or a narrower opportunity set.
Speaker Change: Importantly, this fund will be designated to target institutional investors. It will not be structured as a non-traded REIT, and we do not intend to market to high net worth or retail investors.
Speaker Change: Our fund business is expected to follow the same balance sheet and prudent leverage philosophy that Realty Income ascribes today.
Speaker Change: We do not anticipate an adverse impact on our balance sheet strength or credit ratings. Rather, it will enhance our financial flexibility.
Speaker Change: Realty Income intends to be a meaningful co-investor in the fund while receiving management and potentially incentive fees generated by operation of the fund. These additional earnings would bolster Realty Income's return on investment while ensuring incentives between public and private investors are aligned.
Speaker Change: This approach also reinforces our commitment to transparency and shared objectives.
Speaker Change: In summary, we believe this private capital platform will be complementary and additive to our existing business.
Speaker Change: We intend to take a thoughtful approach to allocating investment opportunities between realty income and the fund to maximize returns for our public shareholders, benefiting both our shareholders and private investors.
Speaker Change: We expect this initiative to enhance our ability to grow our earnings and dividends, expand our addressable market for investments, and reduce our reliance on public equity across market cycles when strategically advantageous.
Speaker Change: We look forward to sharing more information as we progress on launching the fund.
Speaker Change: In closing...
Speaker Change: Our year-to-date performance has exceeded our expectations, propelled by momentum on the investment front, and supported by the stability of our portfolio, consisting of leading clients across the globe.
Speaker Change: Looking forward, I'm optimistic about the multiple verticals for growth we have cultivated for capital deployment. Importantly, pairing these growth verticals with alternative sources of capital will further accelerate the maturation of our platform.
Speaker Change: I would now like to open it up for questions. Operator?
Speaker Change: Thank you. We will now begin the question and answer session.
Speaker Change: To ask a question, you may press star then 1 on your touch-tone phone.
Speaker Change: If you are using a speakerphone, please pick up your handset before pressing the keys.
Speaker Change: To withdraw your question, please press star then 2.
Speaker Change: Today's first question comes from John Kilchofsky with Wells Fargo. Please go ahead.
John Kilchofsky: Thank you. Maybe if we could jump to the 3Q acquisition guide or excuse me, just the acquisition numbers you put up and then talking about the acquisition guide for 4Q. There was a good bit of cap rate compression. Just curious what's going on in the acquisition market. And then maybe part two of that would be
Speaker Change: You have a big step up in terms of acquisition volumes. I'm curious if you can speak to the potential for maybe a transaction on the large 7-11 deal. And then if so, given where we've talked about cap rates being for that deal, is that accretive to your long-term weighted average cost of capital?
Speaker Change: There's a lot of questions you've asked, Jon, so let me just take it one at a time.
Speaker Change: The $740 million that we did in the third quarter at a 74% cap rate, you're absolutely right. It is 50 basis points inside of what we did in the second quarter, which was a 7.9 cap.
Speaker Change: but it is also a function of the cost of capital.
Speaker Change: If you notice, our cost of capital improved during the third quarter vis-a-vis where we were at the beginning of the year. And that improvement was about 65 basis points.
Speaker Change: So, despite the 50 basis points of cash yield compression,
Speaker Change: versus what we had done in the first half. So...
Speaker Change: You know, to look at anything in isolation just based on cap rate or just based on cost of capital, I think, may lead you to the wrong conclusion. So I would request that you take those two pieces in conjunction to figure out what is the true spread that we are being able to cultivate through these investments.
Speaker Change: The second question that you had was around the $1.3 billion approximately that we are anticipating closing in the fourth quarter.
Speaker Change: It is true that we have a very healthy pipeline, and it is largely a function of what we were experiencing for most of the, all of the third quarter, save for what's happened over the last, you know, week, week and a half, where there's been a lot more volatility.
Speaker Change: on the cost of capital side. But that has allowed us to basically build our pipeline and we have essentially forward-funded all of the $1.3 billion that we are planning on investing in the fourth quarter.
Speaker Change: So we have zero reliance at this point, you know, in the public markets to help finance
Speaker Change: what we are planning on achieving with regards to our fourth quarter numbers.
Speaker Change: The volatility in the cost of capital is something that we always take into account, you know, when we are looking at, you know, potential opportunities.
Speaker Change: Making sure that we have enough margin of safety in any particular transaction that we pursue is critical to, you know, how we think about, you know, making investments.
Speaker Change: And long-term, you know, making sure that our hurdle rates on the long-term cost of capital is, you know, superseded by, again, a healthy margin is inherently important to, you know, what we do.
Speaker Change: I'm not going to go into specifics around what transactions make up the fourth quarter. But, you know, we've heard certain comments around
Speaker Change: There being a difference in when you're buying a large portfolio versus the one-off market.
Speaker Change: I can assure you that we are in the one-off market every day.
Speaker Change: And just because you mentioned 7-Eleven, there are 35 transactions that have taken place in 2024 year-to-date.
Speaker Change: And with the same, you know, approximate lease term, et cetera, if you look at where they traded, they traded at a 529 cap rate.
Speaker Change: Anytime we are pursuing a portfolio deal, and there were four large portfolio deals that we were able to accomplish in the third quarter, we make sure that it is at a discount.
Speaker Change: to what we would be able to find in the one-off market.
Speaker Change: And that has played out if you look at what the actual rent is compared to market rent that we bought, the $740 million.
Speaker Change: The rent that is inherent in that $740 million of investments is 6% below market.
Speaker Change: and 26% below replacement costs.
Speaker Change: That is why we feel very confident that on a risk-adjusted basis, the transactions that we are pursuing are ones that will create long-term value for our investors.
Speaker Change: Thank you. And our next question today comes from Greg McGinnis at Scotiabank. Please go ahead.
Greg McGinnis: Hey, good afternoon.
Greg McGinnis: Do you expect the cost of equity in the fund business is going to be lower? And how will investment philosophies between the fund and core business differ to avoid any potential conflicts of interest when determining where an investment should be placed?
Speaker Change: That's a very good question, Greg.
Speaker Change: The biggest difference between the private markets
Speaker Change: and the public markets that I can point to is this focus on first-year spread.
Speaker Change: versus a focus on long-term IRR.
Speaker Change: When we are looking at a particular transaction that is inside of our historical spreads, which has been 150 basis points,
Speaker Change: We hesitate.
Speaker Change: to pursue that transaction because it is not in line with what we can generate in the first year.
Speaker Change: and, as you know better than most,
Speaker Change: that we are valued off of that initial spread that we are able to capture which then translates into AFFO per share growth.
Speaker Change: But that does not allow us to pursue transactions that have a similar, potentially even a higher total return profile, given the inherent growth, et cetera, that they might have, despite having a much lower initial cash cap rate.
Speaker Change: That is where we feel like being able to access.
Speaker Change: Private Capital.
Speaker Change: that had similar expectations on the long-term horizon, the return horizon that we have, we focus on even as a standalone public entity, but not with that short-term focus.
Speaker Change: as acutely as the public entity does, will allow us to expand our sandbox and make investments, you know, alongside this private capital business.
Speaker Change: to take advantage of, you know, much higher growth rate opportunities but potentially at a lower initial yield.
Speaker Change: So we think of this as truly complementary to our business.
Speaker Change: Go ahead, were you going to ask something else?
Speaker Change: type of equity capital will allow you to pursue.
Speaker Change: We've looked at opportunities in the five and a half zip code. We cannot go there today based on where our cost of capital is. With 3% growth, 20-year leases.
Speaker Change: You do the math.
Speaker Change: And you're going to have a return profile that is very much in line with what we're looking for long-term, but we can't pursue that particular transaction because of what, you know, maybe not the dilution, but the non-spread day one.
Speaker Change: That's a perfect example.
Speaker Change: There are other asset types.
Speaker Change: Data centers being a perfect example of another another asset type that is going to fall squarely in this bucket.
Speaker Change: which we may not be able to pursue currently given our cost of capital.
Speaker Change: And that is a particular area of the business that we believe can help drive
Speaker Change: Earnings growth for the public entity.
Speaker Change: You know, in years to come.
Speaker Change: Hopefully that gave you a bit of an insight.
Speaker Change: Our next question comes from Brad Hepburn at RBC Capital Markets. Please go ahead.
Brad Hepburn: Yeah, thank you. So it sounds like really the target for the fund would be just a lower cap rate opportunity set. I'm curious, do you expect that there would be any overlap in the investment profiles between the two vehicles?
Speaker Change: Of course, we are going to continue to be a very large...
Speaker Change: equity holder in the fund. So, you know, our interests are going to be perfectly aligned.
Speaker Change: So there will be a lot of, you know, opportunities that we are going to be looking at, which actually works for both entities long term, but potentially in the short term does not work for the standalone, you know, public entity.
Speaker Change: But this is also going to be a function of, you know, the capital raising.
Speaker Change: We are not going to be buying things into the fund that we would never have touched, even taking the long-term return profile into account as a public entity.
Speaker Change: So this is truly to enhance the box.
Speaker Change: and to pursue transactions, assuming our capital raising is successful, and participate together.
Speaker Change: through the fund structure. That is how we would like to deploy capital.
Speaker Change: Okay. And then, do you have any sort of target in mind for, you know, a size where it makes sense given just the added complication?
Speaker Change: I hope it's going to be very simple, you know, what causes added complication?
Speaker Change: Well, it's a different pocket of capital, but unlike, you know, pockets of capital that have finite life, this is a perpetual vehicle, and we are going to be very large co-investors in this perpetual vehicle.
Speaker Change: And for all intents and purposes, it will be fully consolidated, you know, with our financial statement. So you will have perfect visibility. The fact that we have scale...
Speaker Change: and the fact that we have a platform that we are very proud of.
Speaker Change: unfortunately does not get valued.
Speaker Change: at points in time by the public markets.
Speaker Change: And this is a way for us to monetize this platform and therefore incur very little incremental cost to stand up this vehicle.
Speaker Change: That, too, is a value that our current platform is going to bring.
Speaker Change: I might go so far as to say that, you know, given our size and scale, which we've talked about being such a massive advantage, this is one of the ways that we can show that to the market.
Speaker Change: Thank you. And our next question today comes from Smitty's Rose with Citigroup. Please go ahead.
Smitty's Rose: Hi, thanks. I wanted to ask a little bit about the $63 million charge in the quarter related to convenience store client and is that related to the same client where you took some smaller charges in the first half of the year and could you maybe just talk a little bit more about kind of what the outcome will be there? I guess you can't name the client but maybe a little more color around what's going on there?
Speaker Change: I mean, so first of all, I'd say we absolutely expect a fair outcome. We've talked historically about, you know, situations where we've had credit issues in the portfolio. We've recouped, you know, north of 80 percent of rent that's been impacted.
Speaker Change: As it relates to the accounting that drove the $64 million charge, it's non-cash first and foremost.
Speaker Change: It really has to do with the fact that upon the allocation of the original purchase price,
Speaker Change: You've got land, you've got building, and then you've got this intangible which is meant to account for.
Speaker Change: of Future Cash Flows Inherent in the Lease.
Speaker Change: And so the reserve that you see, which rolls into impairment, but is classified because these were originally sale lease backs as a financing receivable.
Speaker Change: That's really just a difference in nomenclature, and that's why it's excluded from AFSL, it's non-cash. And we've already, you know, effectively accounted for all of the lost rent.
Speaker Change: for the entirety of 2024 that's built into our guidance.
Speaker Change: And I'll just add a little bit to that, because we're talking about credit, let me just share a bit more. I mean, these are assets that we really want control over, and we are doing everything in our power to get control of this asset. It's essentially a client who's decided not to pay rent while operating these assets.
Speaker Change: And we, you know, given the work that the asset management team has done, we already have a tremendous amount of interest in these assets, which are primarily located in Texas.
Speaker Change: And so we feel very confident about being able to replace the rent, which is not significant in this case.
Speaker Change: the actual cash rent that is very quickly once we gain control. So that's this convenience store operator.
Speaker Change: But while we are on the topic of credit, I want to walk you through some of what has dominated the conversations over the last few quarters.
Speaker Change: Red Lobster has emerged from bankruptcy and just hired a CEO, they've hired a chief marketing officer, they've got a new CFO. Let me close the storyline on that. We had 216 assets.
Speaker Change: pre-bankruptcy. Nine assets were rejected through bankruptcy.
Speaker Change: We had a 91% recapture rate on that.
Speaker Change: particular name. Rite Aid.
Speaker Change: We have 29 locations today. We had an 88% recapture rate on Rite Aid, which has now emerged from bankruptcy and is an ongoing concern. Regal.
Speaker Change: where we have 35 assets today at an 85% recapture rate.
Speaker Change: and it has emerged from bankruptcy.
Speaker Change: So those are the storylines that have dominated, you know, multiple quarters of conversations. And this is the end result of all of those conversations. Let's talk about Walgreens. Everybody's concerned about, you know, what used to be a 2,000 store closings, which has now been reduced to 1,500.
Speaker Change: Year-to-date, we've had 13 Walgreens come up for renewal. They had least maturity, all 13.
Speaker Change: were renewed by Walgreens.
Speaker Change: In our history of 55 renewals with Walgreens, we've had a recapture rate of over 100 percent.
Speaker Change: Let's throw CVS in that mix. We've had 40 leases renewed with CVS in our history at over 102% renewal.
Speaker Change: Let's talk about a family dollar-dollar tree.
Speaker Change: We've had 135 lease renewals with Family Dollar Dollar Tree in our history at over 108% renewal rate.
Speaker Change: Daughter gender is a similar story.
Speaker Change: So, I just ask that, you know, what we see in the headlines don't necessarily translate to what is happening on the ground for our portfolio.
Speaker Change: And that's the emphasis I want to make, is that we are very selective, and the data proves that out to be the case.
Speaker Change: Go ahead, Sumit. Sorry, I cut you off.
Sumit Roy: No, I mean, I appreciate the detail as understood, but of course, you know, as we see these headlines, we have to, we have to ask about them, right? I mean, you know, that's the nature of the business. Of course. I wanted to ask you on the, just going back to the fund for a moment.
Speaker Change: I think it was asked previously, but I don't think I heard the answer. Just do you have a sense of kind of what the scope of the fund would be? Are we talking maybe a billion dollars to start, or would you see it in several billions, or kind of how do you think about the size of the fund, I guess, initially, and maybe how it might grow over time?
Speaker Change: Yeah, it's too early to tell.
Speaker Change: We obviously believe in our pieces, we believe in what we are doing, we believe the benefits of what we are doing is going to accrue to our public shareholders. But it is too early, Sumit, for me to opine on how big this could potentially become.
Speaker Change: Thank you. And our next question today comes from Jay Kornreich with SMBC. Please go ahead.
Jay Kornreich: Thank you.
Jay Kornreich: Hi, good afternoon. I was wondering if you can comment on kind of the opportunities that you currently see in Europe, and as you see things today, are you looking into exploring into new territories, and do you expect the acquisition opportunity in Europe to continue to outpace the U.S.?
Speaker Change: That's a great question, Jay, given what we've done in the first three years.
Speaker Change: three-quarters, it is a legitimate question. Yes, 56% of what we've done here today has been in Europe, but we view that as an advantage.
Speaker Change: That's precisely the reason why we created all of these growth verticals, to be able to take advantage of wherever the best opportunities reside. And Europe is where we found that to be the case for the first three quarters.
Speaker Change: I believe the momentum in Europe will continue. We are seeing very good opportunities in Europe. And yes, our ability to go beyond our current geography
Speaker Change: by geography, I mean countries in Europe, is also something that we are constantly looking. And so, you know, for the right opportunity, there are several countries that we don't happen to be in that we would consider going into with the right client and with the right opportunity.
Speaker Change: Thank you for watching. Please subscribe to my channel. I hope to see you again soon.
Speaker Change: Okay, thank you.
Speaker Change: Thank you. Sorry, Gene.
Speaker Change: Rocco, one second, Jay Herd
Speaker Change: Jay had asked about the future as well and so you know the 1.3 billion that that's expected in the fourth quarter I want to close the loop on that with you know the momentum that I had referenced
Speaker Change: was the momentum that we are seeing here in the U.S.
Speaker Change: In Europe, the momentum has continued. It's been there at the beginning of the year, that momentum has continued. But it's in the fourth quarter that you will see it reverting back to more historical norms in terms of U.S. versus international.
Speaker Change: Thank you. And our next question today, yes sir, comes from Handel St. Justin, Missouri. Please go ahead.
Speaker Change: Hey guys, I guess good morning out there to you. Sumit, I wanted to go back to the fund one more time. There appears to be a long list of benefits that you've mentioned already, but I'm also thinking that there could be a long-term benefit of allowing you...
Speaker Change: to potentially generate mid-single-digit AFO growth, your long-term kind of core growth target, without the need for, you know, sizable annual equity raises when you think about your existing rent bumps and the reinvestment of your free cash flow. So I guess, first, is that fair? And then maybe some color on if you'd...
Speaker Change: look to fund it with existing assets within your portfolio and what that makes.
Speaker Change: could look like. Thanks.
Speaker Change: That's a very good question, Handel, thank you. And you're right, I mean, the idea here is we get into this business to expand...
Speaker Change: The Investable Universe for ourselves and for the Fund, while making sure that we adhere to the return expectations of all parties concerned.
Speaker Change: Look, it's a mathematical fact that it's not an issue today, but, you know, ten years from now, at the rate we are growing, if we continue to rely on just the public markets,
Speaker Change: to finance our growth, they're going to run up into, you know, capacity issues.
Speaker Change: I don't believe that the public markets are, especially the fund business, in the public markets.
Speaker Change: are growing at the same level.
Speaker Change: that we have expectations of growing as a public entity. And so it is not a dearth of opportunities that is driving this desire to get into the fund business. It is making sure that this complementary source of equity capital
Speaker Change: you know, will help us.
Speaker Change: monetize our platform.
Speaker Change: and create a business that will then allow, you know, us to continue the momentum that we have shown over the last 55 years, 30 of which has been as a public entity. That is the goal of what we are trying to do. And outside of the initial, you know, call it,
Speaker Change: and Seeding of this Fund, which by the way that portfolio will look and feel very similar to what Realty Income looks like and at the appropriate time all of that will get disclosed is a way to attract capital. This Fund is a way to attract capital. This Fund is a way to attract capital.
Speaker Change: and start our business. But subsequently, you know, it'll be new transactions that they participate in either alongside us or it will be on balance sheet for the public entity. That's how the business is going to function.
Speaker Change: I hope you have a clear handle.
Speaker Change: No, that's incremental, I appreciate that. And one more, and I'm not sure if you answered it, but I didn't quite catch if the pipeline for the fourth quarter, if you expected cap rates to be comparable or lower, and then just thinking about the uptick in volume into the fourth quarter, if that's an appropriate run rate to think about into next year. Thank you.
Speaker Change: Yeah, Handel, I'm not going to opine on cap rates, et cetera, because things can move around quite a bit. But what I will tell you is that the spread that we are going to make will continue to be healthy and will continue to be north of, you know, our historical spreads.
Speaker Change: That you can take a fair amount of confidence. And the other piece I'll leave you with, Hansel, is
Speaker Change: We have already pre-funded our need for the fourth quarter. So there is no reliance.
Speaker Change: You know on the public markets to help fund You know this this 1.3 billion dollars that we are planning on doing in the fourth quarter. Hopefully that helps
Speaker Change: Thank you. And our next question today comes from Spencer Holloway with Green Street Advisors. Please go ahead.
Spencer Holloway: Yeah, thank you. One more on the private fund. Can you maybe just talk about how time will be spent just in terms of underwriting deals and opportunities for the team in general, but also for you, Sumit? And then, I know you commented on economies of scale around your data and data analytics, but just curious if you foresee any changes to headcount or to the investment process just in the early stages of that launch?
Sumit Roy: That's a great question Spencer because it really goes to the heart of when I say you know we're going to use our scale as you know as a company that we are today to mitigate what would be an insurmountable cost for a startup to stop this business.
Speaker Change: News.
Speaker Change: You know we have 465 people in the in the business
Speaker Change: We already have a fully staffed...
Speaker Change: investment on both here in the US as well as in the UK and in Amsterdam.
Speaker Change: taking care of our international business, so we don't see any need for any incremental personnel on the investment side. That's scale benefit number one. Scale benefit number two.
Speaker Change: We are going to be...
Speaker Change: you know, agnostic as to whether these assets are held in a fund, you know, which, by the way, the public entity would have a fairly large interest in, or whether it is on balance sheet.
Speaker Change: And that's our asset management team that has done a superb job on the public side both here in the U.S. as well as in the international markets in London. They will continue to manage these assets.
Speaker Change: That's scale benefit number two.
Speaker Change: Any dispositions, any...
Speaker Change: elements of that. You know, we already have the team here. We have a very large legal team.
Speaker Change: that we are going to leverage, that obviously is a massive source of pride for us given that we do a majority of the work in-house, we will continue to lean on them to help, you know, with transaction negotiations, lease negotiations, etc. That's scale benefit number three.
Speaker Change: You know, we already have the setup in place.
Speaker Change: and so we are not going to be needing new people to help do the block and tackle work that is required of an investment arm.
Speaker Change: Where we will have incremental cost will be around the fund manager and the reporting, as well as an IR function.
Speaker Change: that will be dealing with a very specific type of investor base on the private side.
Speaker Change: but outside of that, from accounting, finance.
Speaker Change: which, by the way, is, again, something we are very proud of. We'll all be leveraged, you know, with the existing platform that we have.
Speaker Change: That's my comment around the incremental cost in standing this business up will be, you know, fairly muted.
Speaker Change: Thank you. It was very helpful. I remember this last one. Can you talk about how the competitive landscape is changing or if there's been any changes in the U.S. and Europe right now as it relates to the transaction market?
Speaker Change: Yes, Spencer, it's, you know, it's very fluid in terms of who we are starting to compete against.
Speaker Change: There is no doubt that private arms are becoming much bigger players in transactions that we are pursuing.
Speaker Change: And, of course, we've had a few more companies in the net lease space that have become public.
Speaker Change: We don't run into most of them given the types of transactions that we pursue, but it is a crowded field in terms of competition here in the U.S.
Speaker Change: In the international market, it continues to be one of the biggest advantages that we have.
Speaker Change: where we are running into more competition today than we did, let's call it a year or two years ago, but it's still not quite as intense as what we experience here in the U.S. And most of that competition comes from private capital.
Speaker Change: in the international market. So that's the flavor of who we compete against in in the US and in the international markets.
Speaker Change: Thank you. And our next question today comes from Upal Rayna with KeyBank Capital Markets. Please go ahead.
Upal Rayna: Great, thanks for taking my question. Subha, you talked about the momentum in the transaction market, but I wanted to kind of get a sense on...
Upal Rayna: on have buyers and sellers really reacted to the 50 basis points rate cut and with another 25 basis points cut likely this week and then with the 10 year really you know driving higher about 65 basis points since the last Fed rate cut so want to get your sense on that.
Speaker Change: Yeah, I think we'll go...
Speaker Change: So much of the volatility across the curve at this point is around what will happen today.
Speaker Change: And, you know, it's the largest exogenous factor that's going to determine where the curve settles down.
Speaker Change: We are not as exposed to the short end of the curve.
Upal Rayna: But it's not to the same extent as we are to the long end of the curve.
Upal Rayna: And so what's happening on the long end of the curve definitely has an impact on our cost of capital, because that becomes a permanent source of financing and, you know, our ability to pursue transactions.
Upal Rayna: And that is a function of, you know, inflation expectations that people have.
Upal Rayna: about, you know, the future.
Upal Rayna: And if policies are going to get put into place...
Speaker Change: where the inflation expectation is going to suddenly be much higher than what it had been traditionally.
Speaker Change: That is going to have an impact on where the 10-year is going to settle. And that will certainly have an impact either on the positive side or on the negative side for the permanent cost of capital for a net lease business.
Speaker Change: and those are largely policy-driven.
Speaker Change: We've had two parties coming up with proposals that have diverse set of impacts on this particular inflation expectation.
Speaker Change: Too early to tell where all of this is going to settle. It is creating a fair amount of volatility and we are hopeful that regardless of, you know, who wins, once we have more clarity in terms of what the curve is going to look like, we'll be able to execute on business as usual.
Speaker Change: Great, that was helpful. And then last one from me, going back to the private capital fund, I know you already listed a bunch of benefits there, but I want to get your sense on why now and why this makes sense in today's economic environment. And I know you mentioned capacity could be an issue in the future, but is there anything else that you may have been dealing with that was creating some friction on your end?
Speaker Change: Really, Opal, there is nothing that we are seeing, either on the credit side, I think I went through a pretty detailed list.
Speaker Change: from the previous quarter. So we feel very good on the credit side. We feel very good on the health of the market to precipitate transactions, you know, setting aside what's happened over the last couple of weeks. But that too shall pass is our expectation.
Speaker Change: Really the timing is around to do this right.
Speaker Change: which obviously is our collective desire.
Speaker Change: We want to do this very slowly and we want to do it very thoughtfully and it's going to take a long time, a long time for this to become a mature business.
Speaker Change: I mean, look at one of our peers who has probably one of the most successful open-ended fund businesses, and that's Prologis, and they've been in that business for 20-plus years.
Speaker Change: And today, it has become, you know, we can step back and say it is a super successful business that some very smart people went into 20 years ago.
Speaker Change: And so, in anticipation of what could happen,
Speaker Change: you know, 10 years from now, et cetera, when we start to run up against this, you know, our desire to put out capital.
Speaker Change: and perhaps, you know, the limits of just accessing the capital sources that we have today, that could become more acute. And so we have to start today to build this history and to build this fund business.
Speaker Change: to a point where it really starts to bear fruit for our public shareholders, etc. And that's it. That's why we're doing it today. There is no, you know, it doesn't matter at which point in the cycle we would have done this. That question would and should be asked.
Speaker Change: But it's really about starting now when we don't have a need for additional capital and building this business to get ahead of what could be a limiting factor multiple years down the road.
Speaker Change: Thank you. And our next question today comes from Linda Sy with Jeffries. Please go ahead.
Linda Sy: Hi, just a few quick ones. Can you give us an update on where 2024 bad debt year-to-date has trended and what's your outlook for 2025?
Speaker Change: Yeah, so Linda, if you look at the earnings release, first nine months of this year, you know, we've incurred about $16 million in bad debt expense. That's around 40 basis points of our rental revenue.
Speaker Change: When you take out this one CSTOR operator that we referenced earlier, you're really looking at sub-20 basis points, like 18 basis points.
Speaker Change: We've talked historically about how, when you exclude the pandemic, you know, we've been right there at around 25 basic points.
Speaker Change: of credit loss in a given year as a percentage of revenue. So to be at 18 outside of this one-time unusual event, you know, we think is pretty indicative of a very constructive and healthy portfolio.
Speaker Change: And I think, you know, we, as Sumit alluded to earlier, you know, the credit watch list at 4.2 percent.
Speaker Change: There's really not a lot out there.
Speaker Change: that, you know, we're really monitoring that.
Speaker Change: meaningful. There's no, you know, one plus percent.
Speaker Change: exposure tenants on there. You know, we feel as though those that are on the watch list, we've been monitoring for quite some time. And in some cases, we have very good visibility into the cash flow coverage.
Speaker Change: on these assets. And so, you know, we'll get into all of the assumptions that we're baking in for 2025 come February when we release our guidance.
Speaker Change: And then in terms of the CSTOR write-down in the quarter, what's the potential AFFO impact on earnings and then what do you think is the recapture rate?
Speaker Change: So in terms of this one C-store operator, it's really, you know, you can call it a million a month or so. And all of that is built in. All of that is built into our guidance.
Speaker Change: And, you know, we'll see where we trend out to in terms of recovery, but as we referenced earlier, we do feel like there is.
Speaker Change: could be quite a bit of interest in these assets. So I think the default response to be able to offer up is you look at our historical precedents and being able to get 84-85% or recapture of any rent that's been impacted by some bankruptcy or credit events.
Speaker Change: Thank you. And our next question today comes from Ronald Camden with Morgan Stanley.
Speaker Change: Let's go ahead.
Ronald Camden: Hey, just two quick ones back to the fund. I think you talked about some of the investments...
Speaker Change: Thanks for watching!
Speaker Change: where the public equity couldn't do it. I guess my other question is just, is there any other differences in terms of dividend policy, in terms of geography, like can the fund go anywhere? And in your mind, is that investor that's going into the fund, is that a completely different investor base that would contemplate the stock or is there some overlap? Thanks.
Speaker Change: get up. Ronald, we haven't really...
Speaker Change: I haven't done any work on the investor profile, but the comments I made about how much bigger this investable universe is of potential investors who look to invest in real estate through a fund structure.
Speaker Change: is what's so compelling. Is it possible that you have some of these funds that have a ambit to invest in public securities and they have a mandate to invest in private direct investments?
Speaker Change: I'm sure that may be the case, but even those investors will tell you that what they have to invest
Speaker Change: to a fund structure directly into real estate.
Speaker Change: multiples.
Speaker Change: of what they have on the security side. So I can't give you a more precise answer than that, but the vast majority, I believe, are going to be investors who, you know, don't have the ability to invest in public securities, but would like to.
Speaker Change: utilize our platform, work with us, and invest in the product that we invest in.
Speaker Change: And outside of that, you know, the strategy is one that I've already touched on. It's not going to be anything new that the fund business is going to be doing that we won't do on balance sheet. Keep in mind that, you know, the goal is we will be a
Speaker Change: a massive co-investor in this fund. And so our interests are going to be perfectly aligned in terms of, you know, what it is that we pursue.
Speaker Change: Great, and then my second quick one is just an update on sort of the data center sort of initiatives. Obviously there's been a lot of data points about demand ramping, just how are you guys sort of seeing the pipeline and that vertical evolving?
Speaker Change: Yeah, so I won't talk about pipelines, Ronald, but what, you know, what you've referenced in terms of the demand...
Speaker Change: We're seeing that in space, and we've been very lucky to be speaking with multiple operators in this space. We see it in terms of what they're showing us.
Speaker Change: regarding the pipeline that they've created. We are trying to craft a value proposition that is compelling to these operators, and we are very optimistic about where this particular business could go for realty income.
Speaker Change: You know, at the end of the day, we are capital allocators, and if we can allocate capital exposed to, you know, S&P 10, S&P 20 clients for 20 years.
Speaker Change: That's our core business, and so we are excited, but it's too early to tell in terms of, you know, how this is all going to play out.
Speaker Change: Thank you. And our next question today comes from RJ Milligan and Raymond James. Please go ahead.
RJ Milligan: I just want to be clear, do you expect the fund to invest in properties that might not necessarily have triple net leases and therefore have better internal growth or more structured investments, development, loans? I'm just trying to get an idea of what the mix is or if it's going to be pure triple net.
Speaker Change: RJ, you know what I'll share with you is you should think of these investments in terms of flow-through, you know, rental income flowing through to NOI to be very similar to what we've, you know, done on balance sheet date.
Speaker Change: The idea is not to go and start executing on businesses that have a 40% NOI margin. That's not what we do.
Speaker Change: versus hyperscale, you know, single-tenant, 20-year leases.
Speaker Change: That may not be precisely triple net, but the flow-through is still incredibly high, i.e. mimicking what a triple net asset should be generating. That's really what we are going to be doing.
Speaker Change: Okay, and then two quick follow-ups, and I may have missed the answers, but number one, do you expect the cost of equity to be higher or lower than realties?
Speaker Change: The cost of equity...
Speaker Change: as defined by long-term return hurdles should be very similar.
Speaker Change: But their focus is on the long-term hurdle rate, not on day one accretion.
Speaker Change: And that's the big difference, RJ. That's why I gave the examples that I did, that the return profile long-term is very similar.
Speaker Change: spread.
Speaker Change: and the long-term hurdle rate. Both those have to be met in order for us to pursue transactions in the public markets today.
Speaker Change: That's how we are valued and we are very grateful for that. We understand that that's how, you know, that's the game we have to play. But there are assets that we are passing up on, very high quality assets that can meet the long-term hurdle, but potentially have a much lower starting point.
Speaker Change: And that, I think, is what we'll be able to do through this fund structure and enhance our co-investment, you know, through the recurring asset management fee stream, which is essentially the monetization of the platform that we have to the benefit of our public shareholders.
Speaker Change: That's how this, you know, will work.
Speaker Change: Okay, and one last follow-up is, will RealtyIncome be contributing properties to the fund?
Speaker Change: There will be a fee portfolio.
Speaker Change: that will allow us to have conversations with potential investors.
Speaker Change: but there after.
Speaker Change: It will be new investments that we pursue. That's how we are thinking about it today.
Speaker Change: that we'll be pursuing.
Speaker Change: Thank you. And our next question comes from Greg McGinnis at Scotiabank. Please go ahead.
Greg McGinnis: Hey Sumit, just wanted to follow up on that last question.
Greg McGinnis: So, you know, you mentioned Prologis, right, and I think that's where the contribution question comes from.
Greg McGinnis: Could you instead maybe envision increasing investment into development, which maybe otherwise you wouldn't have underwritten?
Speaker Change: be contributed to the platform, or would you instead pursue those developments within the platform itself?
Sumit Roy: You know, Greg, that's a very good question because...
Speaker Change: When we pursue development...
Speaker Change: We do have certain accounting
Sumit Roy: elements that we have to adhere to and there are times where we are unable to recognize
Sumit Roy: the full cash impact
Speaker Change: You know, the positive cash yield that we are able to generate.
Speaker Change: on dollars that we are investing in a development scenario, just given, you know, given the lease accounting that we have.
Speaker Change: That's certainly not going to be a prohibitive factor doing it through the fund structure.
Speaker Change: And so, could we do more of those? Yes.
Speaker Change: In the fund, the answer is yes, but again, it needs to meet.
Speaker Change: and exceed the overall return hurdles that we would, you know, we would need to address. So there are a lot of things that, you know, this alternative source of financing could allow us to do, which we have done.
Speaker Change: as a public entity, but only in a limited way because of some of the inherent limitations that we have either in terms of how we can report stuff.
Speaker Change: etc. So I do think that this will give us the flexibility and that's the comment I made about expanding the sandbox of the types of transactions that we would be able to pursue by having this alternative source of capital available to us.
Speaker Change: And do you already have kind of first investors in mind or conversations that you've had on this front?
Sumit Roy: We have none of that in mind. We have we have you know, and I think I've talked about this
Sumit Roy: what the profile of this investor could look like. We certainly have that, and we are working with our advisors who have shared with us, you know, what the details are around that, but we haven't, you know, we haven't had any conversations today.
Speaker Change: Okay, and just a final follow-up for Jonathan. Is there anything specific to point to in the slight increase in the midpoint to the expense leakage guidance?
Jonathan Pong: Yeah, it's a combination of a few things, Greg.
Sumit Roy: Have your load this quarter, I would also say, with this year, I would also say that there are some carry costs that we are...
Sumit Roy: And then also, I think when you're just comparing it to the 1.1% leakage that we experienced last year.
Sumit Roy: slightly more leakage as well.
Sumit Roy: just on a run rate basis. So I would really attribute it to those factors as what's driving the slight increase going from 1.1 and now to a midpoint of 1.35%.
Speaker Change: Thank you. And our next question today comes from Wes Goloday with Baird. Please go ahead.
Wes Goloday: Hey everyone, I just want to have a question on the development pipeline. When do you expect the the non-retail to lease up? Are you holding back leasing on that right now?
Speaker Change: Yeah, that's a great question Wes. Look, it's a very small portion of the overall development. I think it's like 15% plus minus in that zip code.
Speaker Change: And even though the quantum that we have, you know,
Wes Goloday: identified for this particular type of development, we really don't spend till we get clarity on, you know, the leases.
Wes Goloday: coming through. And so we feel very confident, you know, we are partnering with one of the best developers in Panettone.
Sumit Roy: and we feel very confident that you know some of these are going to get leased up in the near term and and keep in mind we won't make the big capital investment without you know having line of sight on you know potential clients being able to step in and take over those leases.
Speaker Change: Maybe just a quick follow-up on that. Since it's more spec in nature, are you going to get a little bit more incremental yield?
Speaker Change: Yes, absolutely, and in fact, in situations where, you know,
Sumit Roy: We've had two buildings. One was leased and the other one wasn't. We have expectations and what we think the lease rates are going to be and
Sumit Roy: So far, you know, more often than not, those lease rates, our expected lease rates, have been superseded.
Sumit Roy: by what actually ends up happening.
Sumit Roy: This continues to build a fair amount of confidence in not only our partner, but also our team's ability to underwrite these types of transactions.
Speaker Change: Thank you and this concludes our question and answer session. I'd like to turn the conference back over to Sumit Roy for any closing remarks.
Sumit Roy: Thank you all for joining us today. We look forward to speaking soon and seeing you at a conference in the upcoming weeks.
Sumit Roy: Thank you, guys.
Speaker Change: Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.