Realty Income Corporation (O) Earnings Call Transcript & Summary

We appreciate everyone being here for the conference call on Realty Income's operating results for the third quarter of 2025. Presenting our figures will be Sumit Roy, who serves as President and Chief Executive Officer; Jonathan Pong, our Chief Financial Officer and Treasurer; Neil Abraham, President of Realty Income International; and Mark Hagan, our Chief Investment Officer. On this call, we may make remarks that qualify as forward-looking statements according to federal securities law. It's possible the company's actual results in the future could vary substantially from what gets covered in any forward-looking statement. The elements that might lead to those variances will be laid out more thoroughly in the company's Form 10-Q filing. <<operator_script>> At this point I'll hand things over to Sumit Roy, our CEO.

Thanks, Andrea, and hello to everyone joining. For 56 years, Realty Income's platform has been built, and it's an income generator with a track record that has demonstrated it can deliver across all sorts of economic environments. Our model runs on data, and when you pair that with decades of institutional know-how and the caliber of talent we have, we're in position to seize on growing investor demand for steady, long-duration income, which is being fueled by aging demographics around the world. On top of that, the scale and diversification we have—over 15,500 properties, 92 industries, and more than 1,600 clients—give us proprietary data insights of strategic value that put us at an advantage over platforms that lack our scale. Lately, we've observed capital formation for net lease vehicles speeding up in the market, and we think our platform is particularly well placed to gain from capital floors that are hungry for long-duration income. As we make our mark in private capital, investors are responding to our lengthy history of generating equity-like total returns paired with bond-like stability. We rolled out a perpetual life fund not long ago, and we anticipate that this initiative will supply extra capital to back our growth goals and strengthen our liquidity. Now to our operating results for the third quarter. Our investment activity keeps showing the various growth levers available to us. The market we can address is large, which lets us evaluate opportunities with essentially no limits tied to geography, property, or industry; because of that, we can chase the best risk-adjusted returns for our shareholders and shift direction easily when we spot capital allocation opportunities that other players may not be able to act on. Around the world, we put $1.4 billion to work at a 7.7% weighted average initial cash yield, which works out to a spread of roughly 220 basis points above our short-term weighted average cost of capital; that pushes our total year-to-date investment volume past $3.9 billion, topping what we finished in all of 2024, aside from the Spirit merger; during this quarter, we sourced $31 billion in volume, which gives us a selectivity ratio of 4.4%. That lifts our total year-to-date sourcing volume to $97 billion, beating our previous annual high watermark for source volume of $95 billion set in 2022; it speaks to how big the market we can address is and to our visibility into global net lease transaction opportunities, thanks to how broad and deep our platform goes. Returning to our investment volumes for the quarter. Once again we favored Europe, which made up about $1 billion, or 72%, of our investment volume at an 8% weighted average initial cash yield. On a risk-adjusted basis, the European investment opportunity keeps looking better than the U.S., where things have grown more and more competitive as smaller platforms chase transactions of similar size. By contrast, the European investment opportunity is still attractive, powered by a competitive landscape that is fragmented, a total addressable market bigger than America's, and a current cost of debt for euro-denominated 10-year notes that sits approximately 100 basis points inside U.S. dollar costs. Since coming into the U.K. Since 2019 in this market, our careful underwriting standards and the strength of our balance sheet have allowed us to grow substantially throughout the continent, and Europe today accounts for close to $16 billion of gross asset value — roughly 18% of the annualized base rent we collect in total. Turning to the U.S., we put $380 million to work at a 7% weighted average initial cash yield. Even though deal activity has slowed at home, that's a matter of being selective rather than a shortage of opportunities, since our priority remains long-term risk-adjusted returns rather than how quickly we deploy capital. Now on to operations. The third quarter shows off the structural benefits built into our business model, among them diversification of the portfolio, which lowers our exposure to idiosyncratic credit risk and backs up sophisticated data analytic capabilities. Along those lines, the proprietary predictive analytics AI tool we've built in-house over the last 6 years guides choices in sourcing, underwriting, lease negotiations and capital recycling; in our view, that makes us proactive operators and strengthens how dependable our long-term cash flows are. At quarter end, the portfolio had more than 15,500 properties across 92 industries and over 1,600 clients. Our essential retail-oriented holdings, which include grocery and convenience stores, are inherently defensive by nature, and together with our scale and diversification, that leaves us well positioned to perform across a range of economic environments. Portfolio occupancy stood at 98.7% when the quarter closed, about 10 basis points better than the previous quarter. Across 284 leases during the quarter, our rent recapture rate came to 103.5%, which works out to $71 million in new cash rents, and 87% of leasing activity came from renewals with clients we already had. We also stayed active in working to optimize the portfolio. During the quarter, we disposed of 140 properties, generating total net proceeds of $215 million. In that same quarter, we sold 18 convenience store properties for roughly $55 million, at a blended 5.5% cap rate and a weighted average remaining lease term of 11.3 years. That pricing sits about 75 basis points below the level at which we buy portfolios of better-quality assets. The deal illustrates strategic portfolio optimization: first, using our scale to pick up assets at a portfolio discount, then monetizing assets that are more mature one at a time at tighter cap rates. Thanks to the sale, we could redeploy capital into better opportunities, which shows we can unlock value through selective dispositions. Last, we recorded $27.3 million, or about $0.03 per share, of lease termination income for the quarter. We book that kind of income when our asset management team, together with input from predictive analytics, concludes that terminating a lease delivers the best probability weighted risk-adjusted net present value outcome. We don't guide to this line item, but we've added historical lease termination disclosure at the bottom of our consolidated income statement in our supplemental. The reason for that disclosure is to improve transparency around the separate and fundamentally different revenue streams of base rent and termination income. All in all, the steadiness of our results keeps showing how our platform's advantages let us stay agile, manage risks effectively and drive long-term portfolio performance. Turning now to what we expect for 2025. Because deal flow keeps building and we've made solid headway so far this year, we're raising the amount we plan to invest in 2025 from $5 billion to roughly $5.5 billion. We're also lifting the bottom end of our AFFO per share outlook, which we now expect to land between $4.25 and $4.27. As we've said before, that guidance builds in about 75 basis points of possible credit loss, and the bulk of it stems from specific tenants we picked up through publicly completed M&A deals. Our credit watch list is still manageable and granular, unchanged from the previous quarter at 4.6% of annualized base rent, with median client exposure of only 2 basis points; with that, I'll hand things over to Jonathan.

Thanks, Sumit. At Realty Income, we've demonstrated over time that we can deliver returns similar to equities while maintaining the steadiness of bonds. Because our earnings are so consistent by nature, that has also let us generate leverage metrics that are easy to predict; when the third quarter ended, net debt to annualized pro forma EBITDA stood at 5.4x, our fixed charge coverage ratio was 4.6x, and liquidity totaled $3.5 billion. On top of that, just 6.5% of our debt when the quarter closed carried a variable rate, and that all stems from our revolver alongside our commercial paper program. After the quarter wrapped up, we completed an $800 million unsecured debt offering split across two tranches, featuring a blended tenor of 5.3 years and a weighted average yield to maturity of 4.4%. We directed the bulk of those proceeds toward repaying $550 million in unsecured notes that had a 4.6% coupon, and we're glad to have gotten this offering done while spreads in our secondary curve remain historically tight. As we always do, we want to express our gratitude to our dedicated fixed income investors for sticking with our platform and for the appreciation they've shown over the years for how comparatively safe our business is and how reliably it generates predictable cash flows. As of right now, we also hold roughly $1 billion in unsettled forward equity, which we think covers all our external equity capital requirements for funding our 2025 investment volume guidance. At this point, I'd like to turn things back over to Sumit for some closing comments.

Thanks, Jonathan. The structural strengths we've built up—things like scale, diversification, discipline, and data analytics—should keep generating value no matter what the economy does. Going forward, we're still centered on running the business consistently and sticking to the disciplined investment approach that's steered us across our 56 years in operation. Delivering dependable, rising income through a diversified net lease platform stays our long-term goal, unchanged. Given our substantial scale and strategic flexibility, we think we're positioned well to stay selective in the current climate and produce enduring value for shareholders as time goes on. At this point, I'd like to turn the call over to questions.

Sumit, you mentioned that Europe remains the market of choice, and part of the reason given for that was tougher competition in the U.S. Do you see this becoming more of a structural thing? Or do you expect the relative appeal and preference between those 2 markets to keep shifting back and forth?

Well, the fact is that here in the U.S. we have a greater number of competitors than Europe does. As you're aware, Brad, looking only at the private side and the recent capital formation aimed at net lease investing from Blackstone, BlackRock, Starwood, there's an entire series of new players coming into the market; so it's clearly the case that competition is heavier here in the U.S.; for us, it comes down to a mix of what's available, which, incidentally, we keep sourcing — out of that $31 billion we referenced, most came from here in the U.S.; it isn't a shortage of product. But with more competition pursuing the same products, we then have to sort of layer in where we get the best value adjusted, risk-adjusted return profile. And that keeps steering us toward Europe, which explains why you saw us put 72% of our investment volume there. Looking at how things stand going forward, I'd say that should persist. Most of what we're seeing will remain in Europe, though we are beginning to observe some degree of momentum here in the U.S. too.

All right, understood. And you clearly kept the initial close for the Core Plus Fund. Could you discuss what you've bought into that fund thus far and how it's different from the deals you've finished outside of it?

Yeah. Brad, regrettably, there's not much I'm able to tell you beyond what's already been made public. Our supplemental shows that we've expanded the disclosure regarding what's going into the fund as opposed to what remains on balance sheet. Because we're in the marketing phase right now for our open-ended fund, there's a strict limit on what we can say about the fund. What we've attempted to do instead is provide you with more disclosure, and I hope you'll find this extra disclosure in the supplemental useful for your modeling, and so on.

Kathryn here, filling in for Michael. To start off, much like what happened in Q2, most of the properties you sold off were empty ones, so I'd appreciate some detail on how the re-leasing effort works. More precisely, who's doing the buying? How long were some of these properties sitting empty? And how does that stack up against the other properties you still plan to sell? Then perhaps give us a sense of how the mix breaks down across the various property types you've been offloading.

Sure. Kathryn, this really is just a natural extension of the approach we kicked off during 2024; we mentioned a comparable volume of sales we intend to complete during this year, and the composition ought to mirror what we saw in 2024. To be sure, looking at where we stand so far this year, empty property sales made up a bigger share, though we did indicate that the latter six months would lean somewhat more toward selling occupied properties. That blend is going to stay the same. From our standpoint, everything hinges on examining a given property and figuring out whether the roster of potential replacement tenants we've got who might take that space — what sort of return could we earn given the rent they'd be prepared to pay, set against the money we'd receive by selling the property while it sits empty; and regarding — we don't favor either route. The sole thing we care about is where we can get the highest economic return from that specific property. That's genuinely what dictates whether we dispose of a property with no tenant in it or instead go find a fresh tenant to fill that property. Consequently, the reality that we offloaded over 100 empty properties formed a piece of our overall plan, reflecting our view that we came out ahead by selling those properties and putting the money back to work in today's market, rather than keeping them, paying carrying costs, and afterward leasing them to a new tenant. That's truly what drove the decision. The mix spans everything — casual dining, quick service restaurants, home improvement. It covers the full range of what we've sold, drugstores included; and it genuinely reflects properties whose leases are approaching expiration, what result we anticipate, and whether selling them empty serves us better. So that's a component of our overall plan and will keep shaping our thinking on asset sales and capital recycling.

Understood, that's quite useful. Now for my follow-up: you brought up the predictive analytics platform, and I'd like to hear your thoughts on how this is expected to lower G&A over a longer horizon, plus how you anticipate leveraging it to achieve some labor efficiencies and other things that might drive G&A down over time.

Yes, Kathryn, excellent question. Let me address the AI strategy from two angles. I'll focus my answer specifically on predictive analytics. This tool leverages machine learning to keep improving the results of this — of its capacity to forecast renewals, and so on. And this specific tool keeps learning each quarter, correct? Lease expirations occur each quarter. The model forecasts a specific result. We compare that result to what actually takes place. And in most instances, the model gets it right, above 90% of the time in many situations; and when it doesn't, it typically learns from that specific mistake by adjusting its — the internal mechanics and the algorithms of that model. So that's how the model keeps getting better and better at forecasting with a far greater degree of certainty what the results will be. And this model gets used when we underwrite transactions on the front end, when we make decisions on the asset management side about whether to keep an asset or sell an asset. It's also heavily used when our asset managers negotiate with our clients, where we have a strong degree of confidence going into a negotiation that this specific location is performing very well. And that confidence clearly feeds into the results we discuss, the re-leasing spreads, and so on; so that's one component of it. And that specific model is used more as a tool to help supplement the years of experience our team brings to making improved decisions. The scale benefits will stem from other AI implementations we're pursuing, where we use tools such as PredictAP, for example, which is a perfect illustration where we had people doing — essentially receiving invoices, monitoring the invoices, entering the invoices into Yardi, and so on. All of that initial front-end work is now handled by an AI tool known as PredictAP. And that's where you began to see the scale benefits, and personnel are moving away from clerical tasks toward more quality assurance and handling approvals to confirm the coding was done properly, and the verification of that coding is being sort of validated by personnel. So that's the point at which you'll begin to notice — and cases similar to that one, which we're taking through the whole organization while evaluating a range of tools, that's the point at which the scale advantages of putting AI tools in place will begin to show up. And our level of maturity differs quite a bit, based on the specific department we're examining and the type of AI rollout we're going to undertake. Yet this is a — it's a path we're traveling, and its payoffs will be delivered to the company in the years ahead. Still, this is something we're highly focused on and something we're quite thrilled to take on.

I'd like to dig a bit into the European loans you closed during the quarter. Seems like you came across some pretty attractive yield opportunities there. Could you tell us who those counterparties were, and whether you'd anticipate a meaningful pipeline of that sort of deal in the coming quarters or so?

Sure, Smedes. As we've mentioned, when we set out along the credit investment route — one of the verticals we wanted to push into — there was a strategic reason driving that. What we told you before was that we already held long positions with these clients. We were entering 15-year and 20-year sale leasebacks alongside them; we were long the credit. We felt very good about that credit; being seen as a one-stop shop, a genuine provider of capital across the whole balance sheet for certain of these clients, was something we wanted to push into, and that describes the composition of every loan we completed in the third quarter — all with existing clients we feel very good about, and we sit higher up on the capital stack. There's a substantial amount of collateral backing these loans, and we can achieve a better yield. Another plus of making credit investments when rates are elevated is that roughly 6% to 7% of our own balance sheet carries exposure to floating-rate debt, and so — that works as a headwind on our financing. Being able to capitalize by putting money into credit investments with elevated yield, again, a consequence of the rate environment we're in, helps offset some of this — some of these headwinds. So for a number of reasons, this is a path we'll keep pushing into, though we'll stay selective. The goal here is ultimately to build tighter relationships with our clients, and hopefully that generates additional sale-leaseback opportunities with this client — which, incidentally, is exactly what happened in the third quarter with 1 of these loan investments we made, where we also ended up completing an off-market $100 million sale leaseback.

All right, that's useful. Then, Jonathan, I have to ask you about the guidance. You mentioned those bigger lease termination fees that, as I understand it, we hadn't anticipated being that high. Is that what's pushing down — or causing the expected drop in your same-store rentals for the rest of the year? Or are those two completely unrelated matters?

Smedes, I'd say the same-store figure stands apart from the lease terminations. Those terminations are one-time in character. If you're attempting to derive something like a comparable AFFO run rate that excludes lease terminations, I believe a few offsets clearly factor in for the latter half of the year, mostly around G&A, which we see simply as putting money into this company's future and widening the competitive moat we gain from; and that requires capital; that requires people. That requires technology, process improvement, and so on and so forth. So the reason that isn't showing up in Q4 within the AFFO run rate, I'd argue, is genuinely those kinds of investments.

Sorry — I've got one more thing I want to ask about the lease term income that showed up this quarter. Was that from 1 or 2 larger tenants? Or is it a mix of tenants?

Most of it came from a single tenant, and truthfully, what's really behind this is how on-the-ball our asset management group has been — getting involved early ahead of potential move-outs and potential credit issues. So that type of activity should be seen as part of ordinary operations from here on, even if the size may not match what we saw in Q3 — but certainly more happening than in earlier periods. Through 2024, we've already recorded about $16 million of lease termination fees on a year-to-date basis. At this point we're at around $30 million. So on a go-forward basis, maybe we will be closer to that $20 million area; still, with more churn and more proactive asset management work, my view is this turns into a more regular occurrence down the road — although likely not as severe as what a single customer drove in Q3.

Congratulations on a really busy quarter for sourcing on the investment side. I noticed the mix of new clients — leases as a share of leasing — moved up to 13%. Could you maybe talk about which industries or segments those new relationships are in?

Jana, we definitely had a handful of new clients come into our portfolio, and some were in Europe. We completed certain logistics deals that brought new clients into our portfolio. By definition, those tended to be among the bigger investments we've made. But I wouldn't place too much weight on the fact that in this particular quarter we had more newer clients than in prior quarters. It's more a result of, as we get more entrenched in Europe, we're beginning to see new clients whose relationships we are cultivating; they may be new to us, but they have existed for many, many years in these markets. And so we — that was the entire reason for entering a market such as Europe, where there are green fields ahead for us. And so that really is the composition of what we wound up doing in the third quarter. But I wouldn't read anything beyond, okay, new relationships means better repeat business possibilities going forward.

I don't want to keep harping on this lease termination revenue, but I'm just trying to get a handle on how much revenue—like annualized revenue—you're essentially forgoing by accepting that lease termination now. Could you perhaps walk us through that?

Sure. Anthony, as you can tell, once again, we're running the numbers, and what we're saying is these are customers who will definitely pay, and setting aside what Jonathan mentioned, in certain instances, there could be credit concerns we're projecting later on that we'd like to capitalize on; however, that wasn't necessarily true for this specific client's circumstances. But if we can secure the bulk of the rent in advance and keep building a stronger relationship and resolve a problem for our specific client, since these are sites that aren't performing as well as most of their other sites, it's a win-win. So that's what happened. When we put together this lease termination, we're ending up, in our view, better off than what would have occurred if we had gathered the rent for the rest of the term. And then we would—we were confident they weren't going to renew the lease and then considering the landscape of, all right, who are the candidates that might step in and weighing that against, all right, having it empty today, receiving the lease termination and disposing of it and redeploying that capital is a much better result for us and better for our clients than simply remaining passive and collecting rent. We could have done that without any trouble and we would have been perfectly okay. But the economic result wouldn't have been as advantageous, in our view, as it ended up being by accepting the lease termination, addressing an optimization issue for our client and putting that capital back to work.

All right, understood. Now for my second question. Sumit, you brought up private equity and other sources of private capital becoming more competitive within the U.S. market. Could you perhaps share a bit more detail regarding the types of assets you're seeing them pursue, or how cap rates might have been affected? Or is there a particular slice of the market that effectively keeps you on the sidelines?

I wouldn't characterize any slice as one that keeps us on the sidelines. What I'm telling you, Anthony, is that these capital formations are out there. These firms do exist. A number of them have even gone as far as publicly stating the exact playbook they intend to run. Certain ones are rather small; therefore, logically, they'll target the one-off market, and that spans the whole range on the lease — on the net lease side; meaning everything from investment grade, lower cap rate transactions with growth, which tends to be industrial. You won't find a great many retail investment-grade, low cap deals carrying substantial growth potential, all the way to higher yielding retail assets with growth. That's precisely what they've described as their specialty. A few are essentially zeroing in on build-to-suit industrial assets, which they believe allow them to secure longer-term deals containing significant growth; and given current conditions, those represent — that's their sharply defined, unmistakable approach. Still others are operating in retail throughout the credit spectrum, so it's — you'll encounter them more often in the one-off market rather than in those very large-scale sale leasebacks that we here in the U.S. tend to chase. That said, we most certainly evaluate the one-off market, and wherever it's sensible, wherever a relationship exists, and wherever parties bring us transactions that aren't marketed or aren't marketed aggressively. We move on those. Yet it's undeniably the case that net lease today has a larger investor base than was true 1 year ago. And that isn't because of additional public companies. It's because of what's taking place on the private side.

Jenny here, filling in for Ron. Just a couple of quick items. The first one concerns same-store revenue growth, which sits at 1.3% year-to-date, yet the guidance points to 1% for 2025 — so does that imply same-store revenue will slow down in Q4? How are we supposed to interpret that?

Jenny, I wouldn't call it a huge deceleration, necessarily. That guidance figure remains right around 1%, though clearly there's a decent chunk of conservatism baked in, since you're still 3 months out and any bad debt expense flows through it. So while nothing material has turned up, that's the reason we tend to hedge somewhat on that front. The third quarter also got a lift from the theater industry. We did pick up some percentage rents, and those pushed the theater same-store figure up into the 5% range. So that's clearly going to settle back down, or at minimum, from a modeling perspective, that's the way we're treating it for the fourth quarter.

Got it, that's clear. For my follow-up, I saw that investment-grade clients made up 31.5% on 9/30, compared with 33.9% back in June. Could you maybe talk a bit about what's behind that shift? Which type of tenant left, or, yeah, whatever's causing the change would be helpful.

Nobody actually vacated — what happened is Dollar Tree divested Family Dollar. Dollar Tree is still investment grade, but Family Dollar has become a privately held business now, so it no longer carries that investment-grade designation. As I understand it, Family Dollar accounts for roughly 2% of the tenants in our registry, and that explains the gap between the fresh figure you see in our supplemental and the one you're measuring it against from Q2.

I had a question — I noticed European investment yields have climbed to 8%, so I'm wondering whether there are particular investments you could highlight, or perhaps other kinds of assets you're putting money into, that produced those higher yields. And can these upper 7% or 8% yields be maintained going forward?

Yeah. Jay, clearly, what gets combined into that figure, that 8% figure, is roughly $380 million of investments we completed on the credit side, and those carried a profile nearer to 9%. So when you combine that with what we did in pure investments on the real estate side, which is roughly 7.3%, that mix is what brings you to that near 8%. But these higher-yielding credit investments were mostly what drove it.

All right, thank you for that. Turning to the re-leasing rent recapture rate — it's been 103.5% for all of 2025. Looking ahead at the lease expiration schedule, with a slight increase beginning in 2027, do you believe those recapture levels are achievable in the years ahead and that they can lift revenue?