Realty Income Corporation (O) Earnings Call Transcript & Summary

We appreciate everyone being with us for this call covering Realty Income's operating results for the fourth quarter and full year 2020. Presenting our results will be Sumit Roy, our President and Chief Executive Officer, along with Christie Kelly, Executive Vice President and Chief Financial Officer. On this call, certain remarks we make might qualify as forward-looking statements under federal securities law. The company's actual future results could differ materially from what these forward-looking statements describe. We will lay out in more detail, in the company's Form 10-K, the factors that could lead to such differences. <<operator_script>>. I'll now hand the call over to Sumit Roy, our CEO.

Thanks, Andrew. Hello, everyone. Since we're still working remotely to keep our employees and community safe, I keep being struck by how resilient and talented our team is in pushing our business ahead through this pandemic. I'm also still grateful for the backing and resilience of our clients and partners, who keep delivering even in difficult conditions. On a personal note, we were thrilled to bring Christie Kelly onto our management team in January as Executive Vice President, Chief Financial Officer; and in February, Michele Bechor came aboard as Executive Vice President, Chief Legal Officer, General Counsel and Secretary. Mike Pfeiffer, who had been Executive Vice President, Chief Officer, General Counsel and Secretary, is going to retire after more than 30 years of service. Through June 2021, Mike will keep serving our company as Chief Administrative Officer, and he'll go on leading our team members while helping Christie and Michelle with their transition at Realty Income until his well-earned retirement. No words can capture everything Mike has given our company across more than 3 decades, and I feel enormously thankful for his partnership with me over the year. Turning to financial matters, with a recap of the quarter and the year. In the fourth quarter, we put over $1 billion into high-quality real estate, $467 million of that in the U.K., which took us past $2.3 billion invested across 2020, roughly $921 million of it in the U.K. Our investments this year went mostly into the grocery and home improvement sectors, and both are still flourishing in today's economic climate; all year we kept leverage low and liquidity plentiful while improving our financial flexibility. Notable items include launching a $1 billion commercial paper program, our successful first public issuance of sterling denominated unsecured notes, and record low coupon rates for 5 years and 12-year dollar-denominated bonds in the REIT sector; we've also stayed active in the equity capital markets to accretively fund our acquisition pipeline. In the fourth quarter of 2020, we brought in about $605 million of equity, mainly via our ATM program. Then in January, we brought in another $670 million of equity through an overnight offering. As a result, our balance sheet is in good shape to handle what remains an active investment pipeline. With that in mind, we're introducing 2021 acquisitions guidance of more than $3.25 billion, since we're well positioned to keep up the momentum from the end of last year and from January; in the fourth quarter of 2020, we invested roughly $1 billion across 70 properties in 22 states and the U.K. at a weighted average initial cash cap rate of 5.4%, with a weighted average lease term of 13.4 years. Measured by total revenue, about 68% of total acquisitions in the quarter came from investment-grade rated tenants. 71% of the revenue comes from retail tenants. These assets are leased to 31 different tenants across 19 industries. Out of the $1 billion that was deployed in the quarter, $541 million went into domestic investments across 59 properties, with a weighted average initial cash cap rate of 5.2% and a weighted average lease term of 15.1 years. In that same quarter, $467 million was placed internationally in 11 properties situated in the U.K., carrying a weighted average initial cash cap rate of 5.7% and a weighted average lease term of 11.7 years. Across 2020, more than $2.3 billion was deployed in 244 properties spread over 30 states plus the U.K., at a weighted average initial cash cap rate of 5.9% and with a weighted average lease term of 13.2 years. Looking at revenue, 61% of what we acquired in 2020 comes from tenants with investment-grade ratings. Retail generates 87% of revenues, while industrial assets account for 13%. These assets are leased to 56 separate tenants spanning 26 industries, and grocery along with home improvement ranked among the 2 most significant industries represented. Within the $2.3 billion deployed in 2020, close to $1.4 billion went into domestic investments across 220 properties at a weighted average initial cash cap rate of 5.8% and with a weighted average lease term of 14.9 years; and roughly $921 million was placed internationally in 24 properties situated in the U.K. at a weighted average initial cash cap rate of 6.1% and with a weighted average lease term of 10.8 years. Deal flow continues to be robust, since we sourced about $17.1 billion in the fourth quarter. Over the entire year, we sourced roughly $63.6 billion in potential transaction opportunities — the highest volume we have ever reviewed in a single year. Within those opportunities, $42.4 billion were domestic and $21.2 billion were international. Investment-grade opportunities made up 50% of the volumes sourced during the year. Out of the $63.6 billion sourced, 56% were portfolios, while 44% — approximately $28.2 billion — were one-off assets. Among the $1 billion in total acquisitions closed in the fourth quarter, 66% were one-off transactions. Our investment spreads relative to our weighted average cost of capital stayed healthy during the quarter, averaging roughly 130 basis points. Turning to dispositions. In the quarter, we sold 60 properties for net proceeds of $77.5 million, realizing an unlevered IRR of 8.7%. That brings us to 125 properties sold during 2020 for $261 million at a net cash cap rate of 7.8%, and we realized an unlevered IRR of 11.6%. Our portfolio stays well diversified by clients, industry, geography and property type, which supports the stability of our cash flow. At year-end, our properties were leased to approximately 600 clients across 51 separate industries located in 49 states, Puerto Rico and the U.K. About 84% of rental revenue comes from our traditional retail properties. The largest component outside of retail is industrial properties at approximately 11% of rental revenue. Walgreens remains our largest tenant at 5.7% of rental revenue. Convenience stores remains our largest industry at 11.9% of rental revenue. Looking at the retail portfolio as a whole, roughly 95% of the rent we receive is paid by tenants whose businesses include a service component, a nondiscretionary component, and/or a low price point component. Our view remains that these traits let those tenants function across many different economic conditions and compete better against e-commerce. Such factors matter a great deal in the current retail landscape, since most of the recent U.S. retailer bankruptcies have occurred in industries lacking these traits. We stay positive about the portfolio's credit quality, given that more than half of annualized rental revenue comes from tenants rated investment grade. Measured by property count, occupancy stood at 97.9% at year-end. In the fourth quarter, 77 properties were released, and we recaptured 100.3% of expiring rents. Across 2020, 314 properties were re-leased, recapturing 100% of the expiring rent. From our 1994 listing onward, more than 3,500 properties with leases expiring have been re-leased or sold, and on those that were released we recaptured over 100% of rent. Given COVID-19, rent collection throughout our portfolio has held steady in recent months. In the fourth quarter, 93.6% of contractual rent due was collected, and further gains in rent collection percentages depend mainly on improvement in the theater industry, which I'll address shortly.

For the fourth quarter, we received 100% of contractual rent from tenants with investment-grade ratings, and that really confirms how valuable our high-quality real estate portfolio is, from the smallest to the largest, well-capitalized clients. Historically, though, we haven't made investment-grade rated tenants a top priority. When the economy is uncertain, tenants with strong credit ratings usually deliver steadier income streams, as the past several quarters have shown. Our Top 4 industries — convenience stores, grocery stores, drug stores and dollar stores — all sell essential goods and account for more than 37% of rental revenue, and since the pandemic started, we've gotten almost all the contractual rent owed to us from tenants in those industries. Uncollected rent is still mostly in the theater industry, making up roughly 80% of uncollected rent in December. Since the theater industry is still struggling, I'd like to give the investment community our latest thinking. That industry accounts for 5.6% of our contractual base. We do expect the industry to shrink going forward, but we still think it will be a viable industry after the pandemic, especially for big-budget blockbuster movies. You may remember that the U.S. box office hit an all-time high as recently as 2018, and 2019 gave us the highest grossing worldwide film ever in Avengers: Endgame. We still believe that for blockbuster movies in particular, a theatrical release will be the distribution channel studios prefer going forward, because the economics are better for them than what streaming platforms offer. That said, we do recognize the industry is changing and that there will likely be a rationalization of theaters in a post-pandemic reality. In that scenario, underperforming theaters may not make it. We continue to carry a full reserve on the outstanding receivable balance for 37 of our 77 total theater assets, and we continue to recognize revenue on a cash basis for those 37 assets. In the fourth quarter, we set up a full reserve for 1 additional theater asset, and we disposed of one theater asset that had previously been on cash accounting. To be clear, we don't expect to lose all of the rent tied to these properties over the longer term, even if there are potential closures. At year-end, the total allowance for these 37 theaters came to $23.7 million, including $1.8 million that is a straight-line rent receivable reserve and therefore has no AFFO impact. Moving on. Our same-store rental revenue fell 3.2% during the quarter and 1.7% year-to-date. Our reported same-store growth includes deferred rent and unpaid rent that we've deemed collectible over the existing lease term, but it excludes rent where collectibility is deemed less than probable. The drop in same-store rental revenue is mainly due to reserves we recognized in the theater industry and, to a lesser extent, the health and fitness industry. Now, to give you more detail on our financial results for the quarter, I'd like to hand it off to Christie.

Thank you, Sumit, and it means a lot to me to be stepping in as Realty Income's CFO. Since coming onto the Board back in 2019, I've seen for myself how talented the Realty Income team is, along with the exciting opportunities for growth that lie ahead for our business. I'm eager to collaborate with our teams in pursuit of our strategic objectives and in helping everyone at Realty Income, alongside Sumit and our Board of Directors, realize their dreams and aspirations. I'm also looking forward to building relationships with our investment community as time goes on; we appreciate the backing of every loyal shareholder who has put money into Realty Income across more than 26 years as a public company and for what lies ahead. Now I'd like to give a broad look at our latest financial results, beginning with the balance sheet. Our capital structure has stayed conservative, and we remain among just a small number of REITs holding at least 2 A ratings. In the quarter, we closed our first-ever public offering of senior unsecured notes denominated in Sterling, issuing GBP 400 million maturing in 2030 with an effective annual yield to maturity of 1.71%. We also issued 725 million of senior unsecured notes in December via a dual tranche offering consisting of 5-year and 12-year notes. That achieved record low U.S. dollar coupon rates for the REIT sector across each of those tenors. Beyond that, we brought in roughly $655 million of equity over the quarter, mainly by way of our ATM program. Then in January 2021, we brought in approximately $670 million via an overnight equity offering, which we set aside to prefund an active investment pipeline for the start of the year. We closed out the year with low leverage and strong coverage metrics, posting a net debt to adjusted EBITDA ratio of 5.3x, or 5.2x pro forma, adjusting for the annualized impact of acquisitions and dispositions made during the quarter. Our fixed charge coverage ratio also stayed strong at 5.1x; we finished the year with full availability under our $3 billion multicurrency revolving credit facility. There were no borrowings outstanding on our $1 billion commercial paper program and more than $824 million of cash on hand. In January, we finished the early redemption of the full $950 million, 3.25 notes due 2022, which we did to lower our near-term refinancing risk and capitalize on attractive borrowing rates in the fixed income market. Looking ahead, our overall debt maturity schedule is in excellent shape, with just $44 million of debt maturities through year-end 2021, excluding commercial paper borrowings. Now turning to our income statement. AFFO per share for the quarter came to $0.84 and $3.39 for the year on a fully diluted basis, which is annual growth of 2.1%. For 2020, our AFFO per share took a negative hit from non-straight-line rent reserves of $44.1 million, amounting to roughly $0.13 per share of dilution, with over half of that tied to the theater industry. Now let's move on to guidance. When we shared our first outlook for 2021 earnings, we recognized that certain uncertainties tied to the theater sector persist, along with the ongoing pandemic situation. Even so, the steadiness and strength of our portfolio, plus our pipeline of acquisitions, give us the confidence to offer this guidance. Accordingly, our 2021 AFFO per share forecast of $3.44 to $3.49 amounts to roughly 1.5% to 3% growth compared with 2020. Now turning to dividends. This past December marked the 109th occasion we have raised our dividend in the company's history. Since the company went public in 1994, we have lifted our dividend annually, achieving a compound average annual growth rate of about 4.4%. We take pride in being 1 of just 3 REITs within the S&P 500 Dividend Aristocrat index that has boosted its dividend each year across the last 25 consecutive years; and at this point I'd like to return the call to Sumit.

Christie, thanks. Looking back at 2020, we remain confident in how resilient our portfolio has proven overall. Our team's tireless work to create shareholder value, plus what we see ahead for the business over the long term. The traction we're seeing in our investment pipeline, the abundant sources of liquidity we have, and our size and scale leave us well placed to seize growth opportunities emerging in the near term worldwide. With that, let's go ahead and take questions. Operator?

First, let me congratulate you on the new position. To kick things off, regarding the occupancy decline you described, I'd like to ask about a couple of aspects. First, what are the plans to fill those spaces again or win back some of that lost occupancy? And second, looking toward '21, what other potential areas of occupancy loss do you see baked in?

Thanks, Vikram — those are excellent questions. At the close of the third quarter, we stood at exactly 98.6%. Someone had asked where we expected to finish the year, and our answer was roughly 98%; the fact that we landed at 97.9% was pretty much on target. What we anticipated was the NPC bankruptcy filing. As you may remember, we hold about 150 assets with NPC, the majority of which are Pizza Hut; we also have 19 Wendy's assets that NPC operates. We expected 66 assets to be rejected during the bankruptcy proceedings. That is why we had guided the market to roughly a 98% occupancy figure. Those 66 assets did return to us in the fourth quarter, and that is the biggest factor behind the 97.9%. You'll notice that the net rise in vacant assets between the third and fourth quarters was around 45 assets. So even though we received 66 assets back, we managed to resolve far more than we had initially anticipated, because these locations are very well positioned, Vikram, and we succeeded in drawing in either QSRs that were interested in taking some of these spaces. We feel quite confident that we can resolve these assets rather quickly. One more thing I'd mention: most of these NPC-operated Pizza Huts had under 2 years left on their lease terms. As a result, our asset management team had already started working out what alternatives existed, fully aware that these assets would be returned to us, even without a bankruptcy filing. So we feel quite good about our ability to resolve them. And as the resolution figures show, we had the highest number of resolutions in the fourth quarter. It was a record quarter for us. That speaks to the team we have in place — Ben and TJ, who lead that process — and they keep doing a truly outstanding job even against the backdrop of the pandemic. We are very optimistic that we will get right back above 98%. See, there's frictional vacancy to account for, and our message to the group has consistently been this: since we want the option to reposition a number of these assets, our occupancy rate is going to stay right around 98% — roughly 98% — because repositioning some of these assets is something we genuinely intend to do, and doing so takes time on our end. That is what we will keep aiming for as we move ahead.

Understood. And Christie, I have a single question for you. Regarding total AFFO growth, I'm aware there may be some dilution, or perhaps short-term headwinds. Clearly, you've prefunded a portion of this. Could you provide a rough idea of how AFFO growth compares in the first half versus the second half on a year-over-year basis?

Vikram, when it comes to where AFFO growth will show up, I'd say you should anticipate something roughly in line with what we've seen historically, except for likely Q2 of last year, when we eased off on acquisitions somewhat. Nothing unusual beyond that.

Could you discuss a little why cash yields fell during the fourth quarter? Across the first three quarters of last year, the average cash yield stood nearer 6%, then dropped to 5% in Q4. So please explain what caused that decrease. You also noted that 61% of 4Q volume came from one-off transactions. So how should we consider the mix between one-offs and portfolios in the near term? And what kind of pricing gap are you observing there?

Yes. That's a good question, Haendel. Like you said, the lower cap rate mostly resulted from the asset mix we bought here in the U.S. If you check the prepared remarks, I noted that 29% of what we acquired here in the U.S. consisted of industrial assets, single-tenant industrial assets; these were very well located properties with customers who are carrying out their omnichannel strategy, had lease terms exceeding 10 years, some 15-year leases, solid growth in markets where we wanted to boost our exposure, and with rents that sat right around market rents. And so, as you're aware, industrial assets generally trade much more aggressively. Consequently, that definitely put a bit of downward pressure on our cap rate, but the fact that we managed 5.2% for the U.S. assets was mostly because of that.

All right. Then perhaps a little detail on the guidance for this year, $3.25 billion. What I'd like to know is how we ought to frame the yields there; and within your dialogue with prospective sellers, I'm wondering whether, given the possibility of a 1031 repeal, you would think about giving units to sellers and how that would be viewed, or any early read — or have you raised that with prospective sellers and what reactions are you hearing about it?

Sure. Once more, those are good questions, Haendel. Look, we came out in early January with what our pipeline looked like for the first quarter; and you may remember we had roughly $800 million — a bit more than $800 million that we had shared with the market back then that we had in our pipeline, and we were 12 days into the year; so it shouldn't have been a shock that we had an extremely robust pipeline built coming out of the fourth quarter. And when you consider what we managed to deliver in the fourth quarter of $1 billion, we had an enormous amount of momentum that essentially rolled forward into the first quarter and that has persisted. It also shows the extent of sourcing that we can accomplish, the new swim lanes that we have established for ourselves to keep expanding the portfolio. And I believe it demonstrates the strategy that we set in motion a couple of years ago to now be able to report figures that appear quite large compared with what we have released in years past. But that is exactly the route that we intended to take. You asked what the expected cap rates are? I think you ought to expect cap rates to be comparable to what we delivered in 2020. And because of the mix of portfolio, the optimal portfolio allocation that we have essentially communicated to the market, it truly is going to depend on which specific portfolio or assets closed within a quarter as to whether the cap rates will land. If it is going to have a somewhat more industrial plan to it, it is going to be lower cap rates. If it is going to be more retail, it is going to have a somewhat higher cap rate. That said, even retail, particularly though those kinds of retail that are deemed essential, portfolios are now trading in the mid-4s. And so the pricing environment has become much more aggressive. But fortunately, we have the cost of capital, and we were still able to produce 160 basis points of spread for the entire year, which is above our historical spread. We're quite pleased with the asset quality we're acquiring and the way we're repositioning the portfolio, consistent with what we told the market in Q3 and so on. So honestly, the cap rate will depend on what mix of assets we close in any particular quarter. Your previous question concerned 1031; and what effect does that have, or how capable are we of issuing OP units. Well, this isn't something new to us. We've completed this before. We've acquired properties from individual investors who preferred — who wished to receive OP units in exchange for their proceeds, and we could accommodate that; so might I envision that trend accelerating as a way to postpone tax obligations? Certainly. And we're extremely well positioned to capitalize on that. And to deploy our equity as a form of payment to offer sellers. Yet despite all that, 1031 represents only a minor portion of what we do, including when it comes to dispositions. As you're aware, the majority of properties we dispose of are typically vacant, and those don't really fit the 1031 marketplace. It's mostly developers or tenants seeking to own their properties who typically participate in that space. And regarding occupied properties, many deals we closed in 2020 involved current tenants exercising their purchase option. That's why we managed to achieve strong proceeds and strong total returns. And opportunistic dispositions are where we might occasionally encounter some 1031 purchasers. But that represents, I'd estimate, roughly 25% of the sellers we deal with. So from our standpoint, I believe the — on the disposition front it will be rather limited; on the acquisition front, I think with 1031 activity not being as vigorous, particularly for smaller properties such as QSRs and drug stores, and so forth; we might observe cap rates rising due to fewer 1031 purchasers; and therefore that could work to our advantage, particularly when we're doing these individual asset purchases.

Hi, Christie — good to have you here, and I can't wait to actually meet you face to face.

I really appreciate that, Haendel. Same here.

So, Christie, let's begin with you. To start, glad to have you aboard. Next, could you quickly unpack the guidance? The acquisition figure of no less than $3.25 billion is a curious way of signaling that you likely expect to exceed that number. Still, with that acquisition assumption in mind, how should we frame what pushes you toward the upper or lower bound of the AFFO per share guidance range?

I realize the question was directed at Christie, and Christie, feel free to chime in. But let me tackle that for a moment, and afterward I'll pass it to Christie, if that works, Greg; on our end, we aimed to ensure the range we issued reflected what we actually see today. We also aimed to keep that range sufficiently cautious that, should conditions fail to get better and instead resemble what we encountered early in the year during January and December of last year, we would still feel quite at ease with it. What I'm implying is that meaningful upside beyond the range we provided may exist. That mostly hinges on how the theater industry overall performs, and to a lesser degree, on how the health and fitness sector does; regarding that, our confidence is strong that theater operations will get better, particularly now that vaccinations have gained traction and each day brings additional updates involving Pfizer and Moderna and possibly J&J joining the approved list, making it quite realistic that we speed toward reaching herd immunity. I've reviewed base case models indicating that by the end of June at the earliest, we might be near herd immunity. Another figure I'd highlight, Greg, is what occurred in China. During the Chinese — Lunar New Year period, they achieved record ticket sales; in fact, a single film that played there earned nearly $50 million above the record previously held by Avengers: Endgame in the U.S. and Canada, and their opening we can't. So these pieces of evidence collectively push us toward thinking that considerable upside may exist relative to the assumptions built into our model. That might help us reach the upper bound of the range. And should many other factors align, we might potentially perform even stronger. But we can't set out with that expectation. Once you consider all the different scenarios. You determine the outcome on a probability weighted basis; that is the figure we provided to the market; however, certain factors might break our way, and it truly depends on your perspective regarding the theater industry and your expectations for what the recovery will resemble. We have told you repeatedly about several assumptions we baked in, specifically regarding taking 37 of our 77 assets, looking at them on a cash accounting basis, and how that flows through the base model. Should your viewpoint change, for instance, to believe that is maybe too conservative, then significant upside exists. That is something we are incredibly enthusiastic about. There are definitely other levers available to us, as you accurately noted, the acquisition market is something we are incredibly enthusiastic about. Part of that is deliberate and part of that stems from a growing number of operators and clients we wish to work with, who are interested in engaging in sale-leaseback transactions. Consequently, that as well might serve as a possible tailwind. And look, we have released numbers. You have observed our track record concerning the initial estimates we release and what we manage to accomplish throughout the year; but I am not claiming that — yet in that area too, there might be some tailwinds. So there are acquisition angles. There are assumptions we have formulated regarding the theater business and the health and fitness business. There are assumptions we have formulated regarding how rapidly we could reach a stage where things begin to normalize, and so on. And each of those possesses room and capacity for potentially exceeding expectations; so we feel fairly good. And I will pass it back to Christie, if there is anything else you would like to add.

Appreciate that, Sumit. And Greg, many thanks for raising it. That said, I fully share the sentiment Sumit expressed. Given the context of 2020, we devoted considerable time, as you might expect, to carefully considering our guidance and to being quite deliberate about how we approached the range we provided for AFFO per share. And, as Sumit noted, several levers exist on the upside for us, including sale-leaseback transactions, somewhat more activity on the acquisition front, and also a hard look, chiefly, at the theater sector. So momentum is favorable. With that in mind, we genuinely feel, just as Sumit put it, quite confident about our present position and the momentum present in our business.

Okay, sure. On your second question, Sumit, inflation keeps coming up more and more when we talk with investors. Could you give us some background on the exposure to lease escalators tied to real TCPI, and on how the company is set up to deliver rising returns compared with peers when inflation is running high?

Yeah, I'd put it at roughly 20%. It may actually be somewhat higher than that. CPI adjustments apply to that portion of our leases. And yet many of them carry both a floor and a ceiling. So in a CPI environment that's climbing, we do have a certain amount of protection, but there's usually — particularly in the U.S., there's usually a floor and a ceiling attached to it. On our side, we've run into this issue previously. What takes place when inflation is elevated? Given that our leases are net lease by nature, we're less, sort of, less exposed to a situation where inflation expectations and actual inflation rise, since so much of the expense — insurance, property, taxes, and so forth — gets covered by our tenants. So from that angle, we feel fairly good. We began to observe the 10-year treasury rising in anticipation of expected inflation moving higher. But fortunately, up to now, our spreads have also narrowed; and our all-in cost on the tenure has risen a bit, though not sharply. We can still issue tenure — in the current environment, we think somewhere around the 2122 ZIP code; and that's still, compared with what we've managed in the past, a very attractive all-in cost on 10-year financing. So we feel fairly good about that. Part of this is now offset by what we're seeing in the U.K. and also in Europe, where interest rates remain low, and inflation expectations are very much in check. And so there, our all-in cost of financing remains extremely exciting; and so the fact that we've built all these various alternatives also helps to shield us somewhat from inflation expectations emerging in specific geographies, and so we feel fairly good about that too. And the fact that our leases are long-term is another plus. Look, at some point, if inflation expectations are climbing, and it's mostly feeding through to stronger GDP growth, and so on, that ought to feed through to better fundamentals for our tenants. And so not so much this year, only about 1.7% of our leases are expiring; but in later years, that should begin to show up in higher market rents, and so on. And so particularly in 2022, 2023, we have somewhat more expiration when it comes to our leases, I could see us marking to market some of our leases at renewal time. And so I think from all those angles, we feel fairly good. A question we hear frequently is this: should interest rates keep climbing, your cost of capital will take a hit — and that's completely accurate. What prior cycles have shown us, though, is that capitalization rates typically move in the same direction; there is certainly a delay involved, yet they do tend to catch up, and that lets us keep holding on to the spreads we currently enjoy. In some cases, we can even widen those spreads when the cap rate rises more quickly than what our capital costs us. So as a company, we believe our position is quite strong; given certain investments we've completed and particular segments we've concentrated on, we believe we're sitting in a very good spot to manage a rising rate environment and growing inflationary expectations.

Hello, and thanks, Christie, for joining this earnings call. I'd like to pick up where we left off regarding the guidance topic. Among the items your team presented was income taxes, which are projected to rise during 2021, and my understanding is that this ties back to activity in the U.K. Could you share additional specifics about what is causing that, and how we ought to view its growth going forward? Also, does U.K. activity account for it?

Yes, Caitlin, that's right. And my sense is that you should anticipate moderate growth as our footprint in the U.K. keeps getting bigger.

All right. So when we consider, say, the increase compared with 2020 on a year-over-year basis, I suppose we should simply expect that, assuming you're putting in a comparable level of investment dollars in the U.K., the income tax dollars might rise at, I'm not sure, roughly a similar sort of rate?

Yes, along the same lines.

All right. Then, regarding the deferrals Realty Income established during 2020, I suppose, could you provide a bit of information about when you anticipate getting those, and if any have already been accumulated, how is that collection effort progressing? In the same way, when will you begin to determine whether the reserves you were setting aside proved cautious — correct? Or conversely, what would be the reverse of cautious, meaning aggressive.

That sounds fine, Caitlin. I believe, above all, what I'm able to state is that concerning the deferrals we have been implementing. Basically, whenever we examine the deferrals in their entirety, what we're truly considering is a near-term repayment occurring inside 18 months; and when it comes to collections and similar matters, we are seeing collections actually prior to the deferrals reaching their due date. Thus, we've been getting some favorable momentum on that front. Having said all that, 2021 still lies ahead of us.

Understood. All right. When we consider what has been factored into the guidance along with those reserves you set aside during the previous year, clearly you provided that guidance range. You offered your perspective expecting it would prove correct, but is it fair to assume that throughout 2021, perhaps even at the start of that year, we will begin to gain some clarity regarding whether the reserves established in 2020 turned out to be appropriate in size?

Yes, yes. And as we work through it, Caitlin, you might already be aware of this, but we conduct an extremely thorough examination of where we stand on receivables, and it spans multiple functions. Finance is part of it, legal is part of it, along with our asset management team and research. So regarding the steps we have implemented, we hold a very strong level of confidence in our reserve position. And looking ahead, our collection activity has remained stable and consistent. At this point in the fourth quarter, we have reached nearly 94% on collections. And truly, if you examine the rent that remains uncollected across our company, it essentially comes down to theaters. The theater segment accounts for 80% of that uncollected rent, and that segment represents 5.6%, as you are aware, of our contractual rent base. The rest of the picture centers largely on health and fitness, which makes up essentially the other 16% of uncollected rent. And we did see some collections come in from the health and fitness operations. As Sumit mentioned and as we have discussed, we still have theaters ahead of us. However, the momentum has been quite positive, and we see that as a possible source of upside for our business moving forward.

I just have one thing about what you said regarding the cinema sector. With that in mind, moving forward, would you consider purchasing theaters on any meaningful scale?

Yeah. Rob, I believe we got this same inquiry during the prior quarter. Listen, expanding into that area is something we enjoy. However, one takeaway from everything we've been through is that when COVID-19 first hit, this accounted for no less than 6% of the total holdings we manage. What we've determined from going through all this is that although this line of business ought to keep going, a certain amount of property consolidation is inevitable. We're quite pleased that we assembled this collection mostly by way of sale leasebacks involving the actual operators; therefore we have strong confidence in the holdings we currently own; yet the plan over the long haul is to keep shrinking how much we're tied to this specific sector until it sits nearer to a 3% range; I trust that addresses what you were asking, Rob. Our view is that eventually, we must reduce it to roughly 3% of everything we hold.

All right, that's useful. So at this stage, what's your thinking regarding acquisitions in Europe outside the U.K., especially considering the situation over there?

Acquisitions in the U.K. rather than Europe — so what's my thinking on buying in the U.K.?

Outside the U.K., in Europe — so the continent — Germany, Scandinavia, beyond Britain — should we anticipate that you view the U.K. as a base from which to pursue larger acquisitions and grow across Europe? For the near term, is it going to end up being just the U.K. at this stage? How do you think about that given the last 12 to 18 months of your experience there? Should we expect another line in acquisitions sometime in 2021 or early 2022, alongside the U.S. and U.K., continental Europe acquisitions?

We've consistently stated that the U.K. Rob, that first step was us pursuing a strategy for Europe — specifically Western Europe — and that's still the direction we're taking. Our presence in the U.K. is quite strong, and I think the figures we've reported back that up. I'm also happy to tell you we've brought on an additional full-time employee at Negara in our U.K. office. This person brings extensive acquisition experience along with plenty of connections and so on across the Western European markets. So what we're aiming for is to keep hunting for deals, without letting geography hold us back, and instead find the transactions that fit best. We've pinpointed certain Western European markets where expansion appeals to us. Whether we move on them mostly comes down to finding operators who are both willing and able to do deals at acceptable valuations, along with other such considerations. So, when asked if we'd consider buying in Western Europe, my response is an unequivocal yes. That said, if you're wondering whether anything will materialize in Spain, I can't give you a schedule for that, nor can I offer one for France, Italy, or Germany. What actually happens will hinge mostly on the opportunities that come up, which partners we're able to engage, and if those partners align with the client roster we're ultimately targeting.

Regarding the financing choices available on that continent, do they look as appealing to you right now as those in the U.K.? If you were acquiring a property, would you arrange funding in the local currency?

Without a doubt. What we've aimed for is to reduce our exposure to currency fluctuations to the greatest extent possible, and we'd take an approach comparable to our U.K. playbook, where we completed our first Sterling issuance, and before that, we had raised money through a private placement in pounds denominated in U.K. currency. That approach will remain our method for funding deals. And here's the part that gets really thrilling, Rob. You're able to issue 10-year paper as euro-denominated debt at 65, 70 basis points. Sure, cap rates have grown far more competitive; yet once you account for what borrowing costs look like for an entity rated A-, A3, it quickly begins to seem quite logical. And I believe that persistently building new sources of capital while exploring further avenues for expanding our operations is exactly what our platform empowers us to do. It's 1 that excites us, and we'll keep driving forward on it.

Brent, most of what I had has already been covered, though there's one thing I wanted to bring up. In the last few years, your exposure to the grocery sector has grown considerably. I realize that was deliberate, and now it accounts for close to 10% of rents. So could you share your longer-term view on that sector, especially considering how much more widely online grocery delivery was adopted during the pandemic? What I mean is — so far, what we've observed is largely local delivery out of stores, but do you see any danger that over time this decouples from the customer's neighborhood store, and perhaps the grocery store starts facing more pressure from an e-commerce standpoint?

Yes. Brent, I'm not sure whether you visit a local grocery store even in the current climate, but you'd still see them pretty crowded. I'm not saying that to be flippant. It's considered essential retail, and these stores have kept performing. That said, the key thing we're concentrating on is that the operators we're looking to work with all have an omnichannel approach. When you consider the U.K. grocers we've teamed up with, they control the click and collect market, and they control the delivery services. That's true of most of the partners we have. And if you break down that 10% — and it isn't exactly 10%, though it's approaching that — of our exposure, you'll see that every operator we've entered into business with is — essentially all of the operators we've entered into business with tend to follow this omnichannel approach, either already very firmly in place or in the midst of getting it firmly in place. They possess the < > and the financial strength to pull it off. And I genuinely believe that will be what this industry looks like going forward, which is exactly why we became so at ease — and it isn't only the industry, it's the operators we've singled out within those industries that we've entered into business with. They won't merely endure but prosper in the new landscape where, potentially, more click and collect or delivery services will exist. So we're quite confident about our particular exposure in this industry. I'm not sure whether this was part of the question — whether we're sort of approaching our ceiling at 10%. My answer would be no. Our investment policy permits us to reach as much as 15%. And when it comes to certain industries, we can always return to the Board and ask for exceptions; naturally, though, we'd need to present our rationale for why it's justified. But this is an industry we're quite at ease with, Brent.