Realty Income Corporation (O) Earnings Call Transcript & Summary

Thanks, everyone, for being with us on this call as we go over Realty Income's operating results for the first quarter of 2022. Joining us to walk through those results are Sumit Roy, our President and Chief Executive Officer, along with Christie Kelly, our Executive Vice President, Chief Financial Officer and Treasurer. As part of today's call, some of what we say may qualify as forward-looking statements under federal securities law. It's possible the company's actual future results could end up differing substantially from anything addressed in those forward-looking statements. A more detailed look at the factors that might lead to such differences will be included in the company's Form 10-Q. <<operator_script>> At this point, I'll hand things over to Sumit Roy, our CEO.

Thanks, Julie. Hello, everyone. We've gotten off to a robust beginning in 2022, and momentum keeps building across our operations. I'd like to convey how genuinely grateful I am to our One Team, whose commitment and teamwork demonstrated just how strong we are by completing the first quarter's close on schedule even while folding in new processes and systems after the VEREIT merger wrapped up last November. Integration work is moving forward on all fronts, and our pledge to keep delivering greater scalability stands. On our ESG initiatives and client partnerships, we keep advancing. This April saw the release of our second annual sustainability report, which lays out our commitments, goals and progress related to ESG. I invite every Realty Income stakeholder to join us in our commitment to fostering sustainable relationships for the good of those we serve, and I urge all of you listening to go through our 2021 sustainability report, available on the Corporate Responsibility page of our website. Turning to macro trends. Inflation remains a major topic occupying the thoughts of numerous stakeholders, and I want to stress our conviction that our business is structured, by design, to create value under these conditions. Ours is a model that produces substantial recurring revenue that reaches the bottom line. Being a triple net lease REIT means our business is shielded from inflation. Taxes, insurance and other operating expenses fall to our clients to cover; and when prices rise, a large share of our clients shift that added cost burden onto their consumers or suppliers. Our adjusted EBITDA margin, which typically sits near 94%, demonstrates how efficient this model is. Keeping a conservative capital structure has been a core principle of our business from the day we were founded, and because we hold a well-staggered, fixed-rate debt maturity schedule with no corporate bond maturities coming due before 2024, our exposure to debt refinancing risk in an environment of rising rates stays limited. In short, we think the attractiveness of our steady, predictable cash flow stream grows even greater amid the kind of volatility we're experiencing right now. With that in mind, we view the most recent stretch when the Federal Reserve raised interest rates—December 2015 through 2018—as a useful case study. Over that stretch, Realty Income's total return beat both the S&P 500 and the MSCI US REIT Index in year 1 of the rate hike cycle as well as across the full 3-year duration of that cycle. And when the Great Recession hit, Realty Income showed lower operational and financial volatility than numerous other S&P 500 REITs holding A credit ratings. On the organic growth side, our asset management team keeps delivering outstanding rent recapture rates; during this quarter, we recaptured more than 106% of rental revenue on leases that expired. With our lease expiration schedule and demonstrated rent recapture track record, we believe we're positioned well to navigate an inflationary environment. Between now and 2024, close to 12% of our portfolio's annualized contractual rent is scheduled to expire. So inflation might actually work in our favor here, pushing rents and construction costs higher. On the buying side, deal flow is still coming in at a solid pace. In certain parts of the market, cap rates have clearly moved up, and as a net acquirer, we think that works to our benefit. What we've seen historically is that cap rates eventually respond to rising interest rates, though it takes somewhere between 6 and 12 months for that adjustment to play out. A big chunk of this cap rate movement traces back to leveraged buyers who depended on historically cheap debt to make their return numbers work. With yields where they are today, our financing approach puts us in a relatively favorable spot. Because of that, we'd anticipate our competitive position getting even better from here. Now let's move to the quarter's results. Our size and scale, combined with the deep relationships we've built across the market, keep paying off through strong sourcing and acquisition activity. During the quarter, we looked at more than $34 billion worth of acquisition opportunities, and roughly 40% of that came from outside the U.S. All told, we acquired about $1.6 billion of properties at the property level this quarter. International investments accounted for about half of our first-quarter volume, which brings our total international portfolio to roughly $5 billion in invested capital. Back in February, we announced that we'd signed a definitive agreement to buy the Encore Boston Harbor Resort and Casino, which is leased to Wynn Resorts under a 30-year triple net lease featuring favorable annual rent escalations. That $1.7 billion deal covers over 3.1 million square feet of high-quality real estate located less than 5 miles from Downtown Boston. Subject to regulatory approvals, we still expect to close this transaction in the fourth quarter of 2022. We think the market is efficient, and although cap rates have leveled off, there's still plenty of competition for the high-quality assets we go after. Our average initial cash cap rate this quarter came in at 5.6%, which speaks to the quality of the locations and tenants we're bringing into the portfolio. Just a reminder that we report cap rates on a cash basis. We estimate that the gap between cash and straight-line cap rates added roughly another 70 basis points in the first quarter. The assets we added this quarter carry a weighted average remaining lease term of 12.3 years, and grocery stores were the top industry we invested in during the quarter. We still have access to capital at attractive pricing, which has let us keep healthy spreads on our investments even with interest rates climbing. We're happy with how strong our core operations continue to be. We closed the quarter with occupancy at 98.6% based on property count. Our overall portfolio has a weighted average remaining lease term of about 8.9 years, which, as I said in my opening remarks, we view as an advantage. When leases come up for renewal, we keep capturing rent at favorable terms. That comes from careful underwriting, the fundamental strength of our properties, and the hands-on work of our seasoned asset management group. In this quarter alone, 119 leases were re-leased, and we brought in 106.2% of the rent that had been expiring. Since we went public back in 1994, we've completed 4,260 re-leases or sales involving expiring leases, and on those re-leased contracts we've brought in more than 101% of rent. We keep sharing our quarterly recapture figures because, in our view, this stands as one of the most objective measures of underlying portfolio quality within the net lease sector. Over the quarter, 34 properties were sold, which produced net proceeds of roughly $122 million. About 84% of the sales volume in that quarter came from former VEREIT properties that went to buyers vacant. Meanwhile, our portfolio posted solid same-store rent growth, up 4.1% for the quarter. That result mostly stemmed from the reversal of $9.4 million in rental revenue reserves during the quarter inside the same-store pool, versus a reserve of $8 million taken on that same pool a year earlier. If you set aside the effect of reserves in both periods, we figure our same-store rent growth would have come in at about 1.2%. With that, I'll hand things to Christie, who will go deeper into the quarter's results.

Thanks, Sumit. In Q1, our operations delivered AFFO per share of $0.98, fueled by robust acquisition activity and a solid portfolio. As Sumit noted, we recorded a $9.4 million reversal of reserves tied to non-straight-line rental revenue during the quarter; the main driver was a $7.7 million reversal of reserves we had outstanding for AMC, which mirrors the rebound from the pandemic. Thanks to how our One Team performed, the strength of what we own, and the strides made in the first three months of 2022, we are reaffirming the 2022 AFFO per share guidance we put out earlier: $3.84 to $3.97, which equals 8.8% annual growth at the midpoint. On the leverage side, we closed the quarter at 5.4x net debt to annualized adjusted EBITDAR, which matches our target leverage ratios; and near-term maturities on our debt stay very small, with a nicely staggered, mostly fixed-rate maturity ladder and nothing due on corporate bonds before 2024. As Sumit said when he kicked things off, the limited debt coming due between now and the close of next year reduces refinancing risk for us while rates are climbing. Being big and scaled means we can tap attractively priced debt in a number of markets; take January, when we sold GBP 500 million of sterling senior unsecured notes, with 5-year and 20-year tranches priced at a blended all-in yield of 2.28% and a weighted average term of 12.5 years. Over the quarter, we raised more than $660 million of equity, mostly via our ATM program. Then, after the quarter closed, we signed a definitive agreement to privately place a GBP 600 million sterling senior unsecured notes offering, with 8-year, 10-year and 15-year tranches priced at a weighted average fixed rate of 3.22% and a weighted average tenor of roughly 10.5 years; we're deeply grateful to the investors who took part in our capital markets deals. Last, only a week ago, we told you about the recast and upsizing of our credit facility, which now carries a $4.25 billion multicurrency revolving line of credit maturing initially in June 2026, along with 2 options to extend by 6 months each, plus a $1 billion accordion feature. With the credit rating we have now, the new revolver gives us a borrowing rate of adjusted SOFR plus 72.5 basis points, versus LIBOR plus 77.5 basis points under the old facility; altogether, 25 lenders joined our recast, and we're very thankful for the backing from our relationship banks, a lot of which have stood with us for decades and have been essential to our growth; we've been busiest over the last 12 months in corporate finance and capital markets. I want to give a special shout-out to Jonathan Pong and his team, who have labored tirelessly to unite our corporate financing strategies and capital markets execution with our partners and bring them to fruition for everyone we serve. Income generation and capital preservation are the founding principles of Realty Income, and our commitment stands to provide monthly dividends that grow over time, forming part of a consistently appealing total shareholder return proposition. During March, we marked the disbursement of our 620th monthly dividend with a virtual ringing of the New York Stock Exchange closing bell. For Realty Income, the dividend is untouchable, and we take pride in being among just 3 REITs within the S&P 500 Dividend Aristocrats Index that have boosted their dividend for a minimum of 25 straight years; furthermore, our business's worth is mostly connected to current income as a vehicle of recurring cash flow. Consequently, the value proposition from holding Realty Income proves comparatively more appealing amid inflationary stretches than for those whose worth is linked to growth in years ahead. And at this point I'd like to hand the call back over to Sumit.

Thanks, Christie. The way our business keeps delivering hasn't changed, and we're set up nicely to extend that momentum across 2022 and afterward. We're living through some fascinating times, and the inventiveness and hard work coming from our One Team keeps my spirits up; when it comes to handing our stakeholders appealing returns adjusted for risk over the long haul, we won't waver. Once more, I want to thank the members of our team and our partners for making these results possible, and our stakeholders for sticking with us. Having said that, I'd like to turn things over for questions.

Brad, you brought up in your prepared remarks that we've observed cap rates rising in some categories. Could you elaborate on that? And do those differences vary based on credit quality or region?

Yeah, absolutely. Appreciate that, Brad. That's a solid question. The clearest shift in cap rates — the increase we're noticing — is within industrial, and it's more pronounced in the U.S. compared to overseas markets. If someone asked me to put a number on how much this has changed, comparing what we observed during Q3 and Q4 of last year against what began showing up in Q1 and afterward this year, I'd put it at roughly a 25 to 50 basis point rise in industrial cap rates. On the retail side, we're beginning to notice certain deals that were signed back in Q4 of last year involving potential leveraged buyers re-entering; certainty of closing has become critically important for sellers, and those buyers are returning with somewhat elevated cap rates. This shows up more in bigger-dollar retail acquisition opportunities, less so with QSR and smaller deals. So we are beginning to observe upward movement in retail, though it isn't as dominant or as widespread as what's happening in industrial.

All right, and so are you observing any businesses that might not have had any interest in a sale-leaseback previously now showing up simply because other financing options have gotten more expensive?

Yeah. I'd say one factor is that a sale-leaseback could be a superior path for generating capital and extracting value from their real estate. But another factor, I believe, is that the sale-leaseback market has matured, particularly in the U.S. We're beginning to witness first-time operators having sale-leaseback discussions, and much of this isn't necessarily driven by activist investors getting involved. A great deal of it happens organically. It's turning into a component of how they manage their balance sheet moving forward. And a number of these are considerably bigger than what we've generally observed in prior years. When I say that, I'm referring to $1 billion upfront as opposed to $1 million. And from our perspective, that reflects the maturation of the sale-leaseback market and, naturally, what's going on right now in the CMBS and secured debt markets.

Greg, you might have yourself muted.

That I definitely did. Thanks a lot, Sumit. Christie, that credit line is now capable of backing a fairly substantial amount of acquisition activity. I'm just wondering how you're viewing possible debt issuance over the remaining part of the year, where do you think you could issue debt, and then your views on sterling and euro debt as opposed to dollar debt right now.

Yes. Appreciate that, Greg. Yes, we're quite thrilled about renewing that $4.25 billion credit facility. The team simply did a fantastic job, and we've had wonderful backing from a group of banks; regarding indicative pricing at present, 10-year U.S. treasuries, we only got this morning above 4%. Let's say 4.2%, 4.3%. If we look at sterling, we're likely in 3.7% range. And then debt tied to the euro, high 2s, 2.8% to 3%; and as you're aware, one element of our strategy is really to capitalize on the European execution from a liability standpoint. So as one component of our capital strategy, we'd be aiming to execute in sterling. And based on how things shake out across the rest of the year, possibly execute from a euro standpoint too.

All right. So when it comes to how you're considering taking on debt during this year — I mean, do you feel like you need to secure more permanent financing rather than drawing on the revolver? Or are you at ease simply because, given where acquisition guidance sits, you'd just keep adding to that?

Greg, what I believe you should anticipate from us is that we'll simply stay steady, the way we did, say, back in April with that private placement of roughly $800 million; there's a delayed draw attached to it, meaning the paydown happens in June. And like you said, we have our revolver, plus we have our commercial paper program, which prices even tighter than the revolver. So there's plenty of opportunity available to us for funding our acquisition volume, and we can do it while staying inside the guidance range.

Perhaps I'll just pick up where that thread of inquiry left off. When it comes to the sterling-denominated debt issuance along with the other efforts to raise capital, where do you stand right now in terms of being protected on a cash flow basis and from an asset exposure standpoint?

Sure. Looking at it through the lens of hedging, we've got arrangements in place that the team put on, covering both the interest rate side. Those were carried out during the 2020 timeframe, in June; and as you might expect, they're sitting in the money; and the way it was structured was really quite solid given the conditions we're seeing today.

And so, regarding growth from outside the company — considering what happened in the first quarter and the casino transaction that's already signed — why didn't you revise your acquisition outlook when putting out these results?

Greg, I apologize, I didn't catch the end there. Would you mind asking that final question once more?

All right, is this coming through?

Yes, it is. Please continue.

Right. What I was asking about was the acquisition guidance that's been kept the same, especially considering how many deals have been done so far this year, plus the casino that's under contract for later on. Are you thinking about raising that guidance, or does the market uncertainty mean it all just gets factored in together?

Right. Nick, as you might remember, our guidance first came out in late October—I believe that was last year—which isn't something we typically do. A big part of the reasoning behind it at the time was making sure folks could properly assess what this merger would mean for the pro forma company. We put out a figure of $5 billion — roughly $5 billion. That figure hasn't been revised. As you mentioned, after that initial guidance came out, we obviously announced a $1.7 billion transaction. What I can tell you, Nick, is that when we first issued the $5 billion, not every bit of that $1.7 billion had been factored in. In fact, at that point we weren't even certain a deal existed. So is it possible the $5 billion gets raised? Yes. But what makes me — what holds us back somewhat is the ongoing volatility we're seeing in the capital markets. And purely from a sourcing standpoint, as the figures we've reported show, looking at the pipeline for the next 4 to 5 months, I can keep telling you the momentum is there; it's extremely strong. What has us sort of hedging is the question of what happens in the final 4 to 5 months should this volatility persist. We feel quite good about the $5 billion figure. And in fact, as we put it, it's above $5 billion. I think we can even go as far as saying that when we released those numbers, not all of that $1.7 billion — which we anticipate closing in the fourth quarter — had been contemplated.

Nick, I wanted to circle back as well, just to confirm I’d fully grasped how broad your question was. And I’d also like to mention that, as we’ve discussed, foreign debt is used by us as a natural hedge for our foreign assets; and the only other item you’d likely care about is that FX forwards are also in place on our side to hedge a portion of our foreign earnings.

Could you provide an update regarding the VEREIT merger, and tell us how the G&A synergies have been trending up to this point?

Absolutely. I'll kick things off. Then, Christie, would you be willing to speak to the run rate on those synergies? As for the integration itself, my view is that it has proceeded as planned. I'd actually take it a step further and say we're ahead of plan. From an organizational standpoint, the 2 companies are integrated. Personnel have settled into their respective teams. Shared procedures, processes, and controls are now in place. And we're clearly witnessing that in areas like acquisitions, asset management, and property management, among others. So organizationally, I believe we're exactly where we hoped to be. When it comes to synergies, I'll hand that question over to Christie.

Appreciate that, Sumit. During the deal, we told everyone our attention was on delivering between $45 million and $55 million of synergies. As things stand today, we're moving toward the top end of that band and running considerably ahead of schedule.

That's useful. As a follow-up, focusing more on Europe. With everything happening there, could you update us on how healthy the investment environment is across Europe generally, and then perhaps discuss a few particular regions? And inside that, your European portfolio leans more heavily toward certain retailers. So how do you — as time goes on, how do you aim to diversify that in order to spread out the exposure?

Sure, Michael. Those are excellent questions. Look, I believe it was intentional that we decided to go into Western Europe. And we deliberately picked the U.K., mainly due to how easily affordable our cost of capital is, along with processes and the tax regime, and so on and so forth. You're completely correct that we've opted to keep working alongside some extremely large operators, and that pipeline of investments has remained a key driver of our growth, bringing us to what is now a $5 billion portfolio. The encouraging part is that the operators we're teaming up with are extremely, extremely large; therefore, there's an enormous amount of runway left for us to keep pursuing that consolidation. I think part of your question also addressed, with everything going on in Eastern Europe, how does that affect us? How does it affect our operators? What I can tell you is, at this moment, every operator we've conducted business with in Europe, not one of them has operations — as of today, not one has operations in Russia, Ukraine, or any of the neighboring countries that might be affected by what's unfolding in Eastern Europe. The sole operator, ironically, with any degree of exposure to Russia is in fact Couche-Tard, which holds roughly 36 assets — under 1% of its total footprint globally — located in Russia. Beyond that, none of our operators as of today have operations in either of those affected nations. So we have an enormous pipeline. We have a considerable amount of runway not just to keep expanding alongside the operators we've already established. But also, as we expand into additional countries with other leading operators there, and a few of these, as you may have noticed, Carrefour was an entirely new name for us, and we completed the sale-leaseback in Spain. We've kept growing that name. And as we keep bringing in more and more countries, and even inside countries, as we grow more at ease with the landscape and the operators, you'll begin to see a handful of other very large names added to our client registry. So, thus far, things are going well. And intentionally, we've remained on the Western side of Europe; and those businesses keep performing well.

So in Q1 you disposed of $122 million, which you described as primarily VEREIT properties. What I'd like to know is how much remains to be sold under that program you've outlined? And also, why did you have so many empty buildings sitting there needing tenants?

Right. Let me take your second question first, Haendel. Within our portfolio of roughly 11,500 properties, approximately 156 sit vacant. As you can see, that's a small share, and it plainly explains our 98.6% occupancy. For us, what happened this quarter was that vacant dispositions accounted for about 97%, 98% of everything we sold — I think the figure came to $118 million, $119 million out of that $122 million. And within that amount, 2 industrial properties we offloaded while empty were the biggest piece, and on those we managed to achieve excellent total return profiles. This pattern will keep fluctuating. Some quarters will include occupied properties that we've chosen to market opportunistically. And obviously, disposing of empty buildings is very much a core element of what we do. Whenever we sell vacant assets, we provide a total return profile showing the unlevered return we managed to generate, and in Q1 that figure exceeded 9% unlevered. These are properties we might have owned for 10, 12, 15 years, producing a decent amount of cash flow. Even sold empty, particularly during inflationary periods, they let us generate and capture the returns we're reporting. But here's the key takeaway I want to leave you with, Haendel: offloading vacant properties is unquestionably a normal component of our operations. We run an asset management review in which we assess what makes the most economic sense — what outcome is most favorable economically, whether that means selling the property, signing a new lease, repositioning it, or negotiating with the current tenant. After working through that process, we choose which route to take. That's what shapes our judgment on whether to dispose of empty or occupied properties. And that approach will remain the guiding principle behind our asset management strategy going forward.