Realty Income Corp

NYSE:O

Earnings Call Transcript 2022-Q1

[Operator]

Good afternoon. My name is David and I will be your conference operator today. At this time, I’d like to welcome everyone to Realty Income’s First Quarter 2022 Operating Results Conference Call. Today’s conference is being recorded. [Operator Instructions] Thank you. Julie Hasselwander, Senior Manager of Investor Relations at Realty Income, you may begin your conference.

[Julie Hasselwander, Senior Manager, Investor Relations]

Thank you all for joining us today for Realty Income’s first quarter 2022 operating results conference call. Discussing our results will be Sumit Roy, President and Chief Executive Officer and Christie Kelly, Executive Vice President, Chief Financial Officer and Treasurer.

During this conference call, we will make certain statements that maybe considered forward-looking statements under federal securities law. The company’s actual future results may differ significantly from the matters discussed in any forward-looking statements. We will disclose in greater detail the factors that may cause such differences in the company’s Form 10-Q. We will be observing a two question limit during the Q&A portion of the call in order to give everyone the opportunity to participate. If you would like to ask additional questions, you may reenter the queue.

I will now turn the call over to our CEO, Sumit Roy.

[Sumit Roy, President and Chief Executive Officer]

Thanks, Julie. Welcome everyone. 2022 is off to a strong start, and we are continuing to build momentum in our business. I want to express my deep appreciation of our One Team whose dedication and collaboration showcased the strength of our team through a timely closing of the first quarter, while integrating new processes and systems following the close of the VEREIT merger last November. All integration efforts are progressing and we remain committed to delivering continued scalability.

We continue to make progress on our ESG initiatives and partnerships with our clients. In April, we published our second annual sustainability report, which details our commitments, goals and progress on our ESG efforts. I welcome all Realty Income stakeholders to share in our dedication to build sustainable relationships for the benefit of those we serve and encourage everyone listening to read through our 2021 sustainability report, which can be found in the Corporate Responsibility page of our website.

Looking at macro trends, inflation persists as an important topic on the minds of many stakeholders and I want to emphasize that we believe our business is by design well-positioned to drive value in this climate. Our business model is one that generates significant recurring revenue that flows through to the bottom line. As a triple net lease REIT, our business is insulated from inflation. Our clients are responsible for covering taxes, insurance and other operating expenses. And as prices increase, many of our clients pass the incremental cost burden on to their consumers or suppliers. The efficiency of our model is reflected in our adjusted EBITDA margin, which is routinely around 94%. Maintaining a conservative capital structure has been a key tenet of our business since our founding and having a well-staggered fixed rate debt maturity schedule with no corporate bond maturities until 2024 limits on debt refinancing risk in a rising rate environment.

In summary, we believe the appeal of our consistent and predictable stream of cash flows is amplified during periods of volatility like we find ourselves in today. To that end, we look at the last period in which the Federal Reserve increased interest rates from December 2015 through 2018 as a helpful case study. During this period, Realty Income’s total return outperformed the S&P 500 and the MSCI U.S. REIT Index both in year 1 of the rate hike cycle and throughout the 3-year duration of that cycle. And during the Great Recession, Realty Income exhibited less operational and financial volatility as compared to many other S&P 500 REITs that carry A credit ratings.

From an organic growth standpoint, our asset management team continues to report impressive recapture rates. This quarter, we recaptured over 106% of rental revenue on expiring leases. Given our lease expiration schedule and proven rent recapture track record, we believe we are well-positioned to manage through an inflationary environment. Through 2024, nearly 12% of our portfolio annualized contractual rent is set to expire. And in this regard, inflation could serve as a tailwind to our business as rents and costs to build rise.

On the acquisition front, our transaction flow remains strong. Certain categories of the market, has seen discernible increase in cap rates, which we believe should accrue to our advantage as a net acquirer. Historically, we have observed that when interest rates increase, cap rates are just following a lag period of 6 to 12 months. Much of this cap rate expansion can be attributed to levered buyers who have relied upon record low debt pricing to underwrite their returns. Given the current yield environment, we are in a comparatively strong position given our financing strategy. And as such, we would expect our competitive standing to strengthen further.

Now, turning to the results for the quarter, our size and scale, in conjunction with strong relationships we have across the marketplace, continue to provide benefits through robust sourcing and acquisition volumes. This quarter, we sourced over $34 billion of acquisition opportunities. And approximately 40% of this amount was sourced from international markets. Our total property level acquisitions for the quarter, was approximately $1.6 billion. Approximately half of our volume in the first quarter was the result of international investments, bringing our total international portfolio to approximately $5 billion of invested capital.

As we announced in February, we signed a definitive agreement to acquire the Encore Boston Harbor Resort and Casino leased to Wynn Resorts under a 30-year triple net lease with favorable annual rent increases. The $1.7 billion transaction includes more than 3.1 million square feet of high-quality real estate less than 5 miles from Downtown Boston. Pending regulatory procedures, we continue to anticipate this transaction closing during the fourth quarter of 2022.

We believe the market is efficient. And while cap rates have stabilized, significant competition remains with the high-quality assets we pursue. Our average initial cash cap rate for the quarter was 5.6%, which reflects the quality of locations and clients we are adding to our portfolio. As a reminder, we report our cap rates on a cash basis. We estimate the difference between cash and straight line cap rates to be approximately an additional 70 basis points in the first quarter. The weighted average remaining lease term of the assets added to our portfolio during the quarter was 12.3 years and the top industry invested during the quarter was grocery stores. We continue to have access to attractively priced capital, which has allowed us to maintain healthy spreads on our investments even as interest rates rise.

We are pleased with the continued strength of our core operations. We ended the quarter with our portfolio at 98.6% occupancy based on property count. The weighted average remaining lease term of our overall portfolio is approximately 8.9 years, which as I mentioned in my opening remarks, we see as an advantage. As leases roll, we continue to favorably recapture rent as a result of diligent underwriting and the inherent quality of our real estate enhanced by the proactive efforts of our experienced asset management team. This quarter, we re-leased 119 leases, recapturing 106.2% of expiring rent. And since our public listing in 1994, we have executed 4,260 re-leases or sales on expiring leases, recapturing over 101% of rent on those re-leased contracts.

We continue to report our quarterly recapture rates, because we believe this is one of the most objective ways to measure underlying portfolio quality in the net lease industry. During the quarter, we sold 34 properties, generating net proceeds of approximately $122 million. Approximately, 84% of the sales volume during the quarter related to former VEREIT properties that were sold rated. And our portfolio delivered healthy same-store rent growth increasing 4.1% during the quarter. This was largely attributed to the reversal of $9.4 million of rental revenue reserves during the quarter within the same store pool compared to a reserve of $8 million recognized for the same pool during the year ago period. Excluding the impact of reserves in both periods, we estimate that our same-store rent growth would have been approximately 1.2%.

At this time, I will pass it over to Christie who will further discuss results from the quarter.

[Christie Kelly]

Thank you, Sumit. During the first quarter, our business generated AFFO per share of $0.98 supported by a strong acquisition pace and a healthy portfolio. As Sumit mentioned, during the quarter, we recognized a $9.4 million reversal of non-straight line rental revenue reserves. This was primarily driven by the $7.7 million reversal of our outstanding reserves related to AMC, reflecting the recovery from the pandemic.

Given the performance of our One Team, the health of our portfolio and progress achieved during the first quarter of 2022, we reaffirm our previously announced 2022 AFFO per share guidance of $3.84 to $3.97, representing 8.8% annual growth at the midpoint. From a leverage standpoint, we ended the quarter with a net debt to annualized adjusted EBITDAR of 5.4x in line with our target leverage ratios. And our near-term debt maturities remain minimal with a well-staggered predominantly fixed rate debt maturity schedule and no corporate bond maturities until 2024. As Sumit mentioned in his opening remarks, our modest debt maturity schedule through the end of next year limits our refinancing risk in a raising rate environment.

Our size and scale provide us access to attractively price debt across several markets. For example, in January, we issued £500 million in sterling-denominated senior unsecured notes, pricing 5-year and 20-year notes at a blended all-in yield of 2.28% with a weighted average term of 12.5 years. During the quarter, we issued over $660 million of equity primarily through our ATM program. And subsequent to the quarter end, we entered into a definitive agreement for the private placement of a £600 million sterling-denominated offering of senior unsecured notes, pricing 8-year, 10-year and 15-year notes at a weighted average fixed rate of 3.22%, with a weighted average tenor of approximately 10.5 years. We greatly appreciate the support from the investors who have participated in our capital markets transactions.

Finally, just last week, we announced the recast and upsizing of our credit facility, which now includes a $4.25 billion multicurrency revolving line of credit with an initial maturity in June 2026 and two 6-month extension options as well as a $1 billion accordion feature. At our current credit rating, the new revolving line of credit provides a borrowing rate of adjusted SOFR plus 72.5 basis points as compared to our previous credit facility of LIBOR plus 77.5 basis points.

In total, 25 lenders participated in our recast and we greatly appreciate the support of our relationship banks, many of whom have supported us for decades and have been integral towards our growth. We have been most active during the last 12 months within corporate finance and capital markets. I’d like to make special mention of Jonathan Pong and his team who have worked tirelessly to bring our corporate financing strategies and capital markets execution together with our partners to fruition on behalf of all whom we serve.

Realty Income was founded on the principles of income generation and capital preservation. We remain committed to delivering monthly dividends that increase over time as part of a consistently attractive total shareholder return proposition. In March, we celebrated the payment of our 620th monthly dividend by virtually bringing the New York Stock Exchange closing bell.

At Realty Income, the dividend is sacrosanct and we are proud to be one of only three REITs in the S&P 500 Dividend Aristocrats Index for having raised our dividend for at least 25 consecutive years. And the value of our business is largely tied to current income as a recurring cash flow vehicle. As a result, the value proposition of owning Realty Income is comparatively more attractive during inflationary periods versus those whose value is tied to growth in future years.

And now, I would like to pass the call back to Sumit.

[Sumit Roy, President and Chief Executive Officer]

Thank you, Christie. Our business continues to perform and we are well-positioned to build on our momentum throughout 2022 and beyond. These are interesting times and I remain encouraged by our One Team’s creativity and work effort. We remain steadfast in our pursuit of providing our stakeholders with attractive risk-adjusted returns over the long-term. Thank you again to our team and partners for helping us deliver these results and to our stakeholders for their continued support.

With that, I’d like to open it up for questions.

[Operator]

Thank you. [Operator Instructions] We will take our first question from Brad Heffern with RBC Capital Markets. Your line is open.

[Brad Heffern, RBC Capital Markets]

Hey, everyone.

[Christie Kelly]

Hi, Brad.

[Brad Heffern, RBC Capital Markets]

Hi, Christie. Sumit, you mentioned in your prepared remarks that you have seen an increase in cap rates in certain categories. Can you give more color there and are there differences by credit quality or geography?

[Sumit Roy, President and Chief Executive Officer]

Yes, sure. Thanks for the question, Brad. Good question. I think the most obvious difference in cap rates – increasing cap rates we see is in the industrial sector and more so here in the U.S. than in the international markets. I would say if I was asked to quantify what this change is in terms of what we were seeing in the third and fourth quarter of last year to what we started to see in the first quarter and beyond of this year, I would say it’s in the tune of 25 to 50 basis points of increase in cap rates on the industrial sector. We are also starting to see on the retail side some of the transactions that were struck again in the fourth quarter of last year with potential levered buyers coming back. And certainty of close is taking on paramount importance with regards to the sellers and they are coming back at slightly higher cap rates. We see this more on the larger dollar retail acquisition opportunities, not so much on the QSR and smaller opportunities. But we are starting to see movement higher on the retail side, but it is not as dominant and it’s not as widespread as we see it on the industrial side.

[Brad Heffern, RBC Capital Markets]

Okay. Thank you for that. And then are you seeing any companies that potentially wouldn’t have been interested in sale leaseback in the past come in just given the higher cost of alternative forms of financing?

[Sumit Roy, President and Chief Executive Officer]

Yes. I think part of it is that sale leaseback may potentially be a better avenue to raise capital and monetize their real estate, but I think part of it is also the maturation of the sale leaseback market, especially here in the U.S. We are starting to see first time operators engaging in sale leaseback conversations and a lot of it is not necessarily being generated by activist investors coming into play. A lot of it is organic. This is becoming part of their balance sheet management strategy going forward. And some of these are much larger than what we have typically seen in years past. And when I say that, I mean with $1 billion in front rather than $1 million. And to us, it is a function of the maturation of the sale leaseback market and of course, also what is happening on the CMBS and secured debt markets today.

[Brad Heffern, RBC Capital Markets]

Okay, thank you.

[Operator]

Sure. Next, we will go to Greg McGinniss with Scotiabank. Your line is open.

[Christie Kelly]

Hi, Greg.

[Sumit Roy, President and Chief Executive Officer]

Greg, you maybe on mute.

[Operator]

Yes, Greg. Your line is open.

[Greg McGinniss, Scotiabank]

I certainly was. Thank you so much, Sumit. So, good afternoon. Thanks for taking the question. Christie, the line of credit can now support a pretty significant level of acquisition activity. Just curious how you are thinking about maybe debt raises through the balance of the year, where do you anticipate you could raise debt and then thoughts on sterling and euro debt versus dollar debt at this point?

[Christie Kelly]

Yes. Thanks for that, Greg. Yes, we are very excited about the renewal of our $4.25 billion credit facility. The team just did a great job, and we’ve got great support from a lineup of banks. In terms of indicative pricing right now, 10-year U.S. treasuries, we just received this morning above 4%, call it, 4.2%, 4.3%. When we look at sterling, we’re probably in 3.7% range. And then euro-related debt, high 2s, 2.8% to 3%. And as you know, part of our strategy is to really take advantage of the European execution from a liability perspective. And so as part of our capital strategy, we’d be looking to execute in sterling. And depending on how things pan out throughout the rest of the year, potentially execute from a euro perspective as well.

[Greg McGinniss, Scotiabank]

Okay. And then in terms of how you might be thinking about raising debt this year, I mean, do you guys feel a need to get more permanent financing versus using the revolver? Or are you comfortable just based on where the acquisition guidance is just continuing to load up there?

[Christie Kelly]

I think what you can expect from us, Greg, is to just really be consistent as we executed, for example, in April with the private placement of approximately $800 million. We have a delayed draw on that. So the paydown is in June. And as you mentioned, we’ve got our revolver, and we also have our commercial paper program that is even further pricing inside the revolver. So we’ve got a lot of opportunity here in front of us to fund our acquisition volume and do so within the range of guidance.

[Greg McGinniss, Scotiabank]

Okay, thank you very much.

[Christie Kelly]

Thanks, Greg.

[Operator]

Next, we will go to Nicholas Joseph with Citi. Your line is open.

[Nicholas Joseph, Citi]

Thank you. Maybe just following up on that line of questioning. Just with the sterling debt issuance and the other capital raising, how hedged are you from a cash flow and asset exposure perspective today?

[Christie Kelly]

Hi, Nick. Yes. So from a hedging perspective, we have hedges in place that we’ve executed both from an interest rate perspective. The team executed those back in the 2020 time period in June. And as you can imagine, we’re in the money. And it was very well designed as it relates to the current environment.

[Nicholas Joseph, Citi]

Thanks. And then just on external growth. I mean just given the 1Q activity and then the casino deal under contract, what were your thoughts on moving acquisition guidance with this earnings release?

[Sumit Roy, President and Chief Executive Officer]

Nick, sorry, you cut off. Could you repeat that last question, please?

[Nicholas Joseph, Citi]

Sure. Can you hear me?

[Sumit Roy, President and Chief Executive Officer]

Yes, I can. Go ahead.

[Nicholas Joseph, Citi]

Yes. So the question was just on maintained acquisition guidance, just given the pace of acquisitions year-to-date and then also with the casino under contract for later in the year, if there are thoughts of moving up the acquisition guidance or just given kind of the uncertainty in the market, how that all blended together in your thinking?

[Sumit Roy, President and Chief Executive Officer]

Yes. So Nick, if you recall, when we first came out with our guidance, this was in late October, I think, of last year, which was very unusual for us, and a lot of what was driving that thinking then was making sure that people were able to underwrite what this merger was going to mean for the pro forma company. And we had come out with a number of $5 billion, approximately $5 billion. We haven’t changed that. And like you’ve said, we’ve obviously made the announcement subsequent to that initial guidance of a $1.7 billion transaction. And what I can share with you, Nick, is not all of that $1.7 billion was contemplated when we had first come out with the $5 billion. In fact, we weren’t even sure we had a deal at that time. So could that $5 billion go up? Yes. But what I – what keeps us a little bit on the sidelines is this continued volatility that we are seeing on the capital markets side. And from a pure sourcing perspective, as you can see from the numbers that we’ve posted, from a – the next 4 to 5-month pipeline perspective, I can continue to share with you that the momentum is there. It is incredibly positive. And what sort of keeps us sort of hedging is what’s going to happen in the last 4 to 5 months if this continued volatility remains. We are very comfortable with the $5 billion number, and it’s actually, we say, above $5 billion. And I think we can also go so far as to say that not all of that $1.7 billion, which we expect to close in the fourth quarter, was contemplated when we came out with the numbers that we did.

[Nicholas Joseph, Citi]

Thank you.

[Sumit Roy, President and Chief Executive Officer]

Sure. Thanks, Nick.

[Christie Kelly]

Nick, I just wanted to follow-up, too, to make sure that I captured the breadth of your question. I also wanted to just share that as we’ve talked about, that we use foreign debt to serve as a natural hedge on our foreign assets. And probably the only other thing you’d be interested in is we also have FX forwards in place to hedge some of our foreign earnings.

[Operator]

Okay, alright. Next, we will go to Michael Goldsmith with UBS. Your line is now open.

[Michael Goldsmith, UBS]

Good afternoon. Thanks for taking the question. Can you give us an update on the VEREIT merger and how the G&A synergies are trending so far?

[Sumit Roy, President and Chief Executive Officer]

Sure. I’ll start off. And then Christie, if you wouldn’t mind just addressing the run rate on the synergies. With regards to the integration itself, I think it has gone according to plan. I would even go so far as to say it’s ahead of plan. The two companies are integrated from an organizational perspective. The personnel have integrated into their various teams. Common procedures and processes and controls have been adopted. And we are clearly seeing that on the acquisition front, on the asset management front and the property management front, etcetera. So I think organizationally, we are where we were hoping to be. In terms of synergies, I’ll let Christie take that question.

[Christie Kelly]

Thanks, Sumit. So we had shared during the transaction that we were focused on executing $45 million to $55 million in synergies. And from the perspective of where we are right now, we’re tracking towards the higher end of that range and well ahead of plan.

[Michael Goldsmith, UBS]

That’s helpful. And as a follow-up, more focused on Europe. Given what’s transpiring there, can you provide an update on the health of the investment landscape in Europe broadly and then maybe touch on some of the specific regions? And then within that, your European portfolio is more concentrated in certain retailers. So how do you – over time, how do you look to diversify that to kind of spread – to spread out the exposure? Thank you.

[Sumit Roy, President and Chief Executive Officer]

Sure, Michael. Very good questions. Look, I think by design, we had chosen to enter into Western Europe. And we, by design, chose the UK primarily because of the ease of affordability of our cost of capital and processes and tax regime, etcetera, etcetera. You’re absolutely right that we have chosen to continue to work with some very large operators, and that investment pipeline has continued to be a major source of our growth of what is today a $5 billion portfolio. The good news here is the operators that we are partnering with they are very, very large. And so there is a tremendous amount of runway for us to continue to do the consolidation. I think there was an element of your question that also touched on, given what is happening in Eastern Europe, how are we impacted? How are our operators impacted? What I can share with you is, as of right now, all of the operators that we have done business with in Europe, none of them have operations today. None of them have operations in Russia, Ukraine or any of the adjacent countries that are potentially being impacted by what’s playing out in Eastern Europe. The only operator ironically that does have some element of exposure to Russia is actually Couche-Tard that has about 36 assets, which is less than 1% of their overall footprint – global footprint that is based in Russia. And outside of that, none of our operators today have operations in either of those impacted countries.

So we have a tremendous amount of pipeline. We have a fair amount of runway to not only continue to grow with the operators that we’ve established, but also as we branch out into new countries with other dominant operators in those countries, and some of which, as you can tell, Carrefour was a brand new name for us, and we did the sale-leaseback in Spain. We have continued to grow that name. And as we continue to add more and more countries, and even within countries, as we get more comfortable with the landscape and operators, you’ll start to see a few other very large names get added to our client registry, so, so far, so good. And by design, we’ve stayed on the western side of Europe. And those businesses continue to do well.

[Operator]

Okay, alright. We will go to our next question, Haendel St. Juste with Mizuho. Your line is open.

[Haendel St. Juste, Mizuho]

Hey, I guess, it’s good afternoon out there, as well.

[Christie Kelly]

Hi, there, Haendel.

[Haendel St. Juste, Mizuho]

Hi, there. So you guys sold $122 million in the first quarter, you said mostly VEREIT assets. But I guess I’m curious how much more is there left to sell in that platform that you’ve identified? And I guess why were there so many vacant properties there to lease? Thanks.

[Sumit Roy, President and Chief Executive Officer]

Yes. It’s about – so I’ll answer your last question first, Haendel. There is about 156 assets that are vacant in our portfolio close to 11,500 assets. So it’s not significant, as you can tell which is clearly why we have 98.6% occupancy. Look, for us, it is – this quarter happened to be one where of all the assets sold, about 97%, 98% – I believe it was $118 million $119 million of the $122 million were vacant asset sales. And even that number was largely dominated by two industrial assets that we sold vacant where we were able to strike very good total return profiles. This is going to continue to ebb and flow. There’ll be quarters where we have some occupied assets that we have opportunistically decided to sell. And clearly, selling vacant assets is very much part and parcel of our business. And when we do sell vacant assets, we give you a total return profile on what is the unlevered return that we were able to achieve, which this first quarter was north of 9% on an unlevered basis. So these are assets that we may have held for 10, 12, 15 years, have generated a fair amount of cash flow. And even when sold vacant, especially in inflationary environments, it allows us to create and capture the kind of returns that we are posting.

But the point I want to make and I want to leave with you, Haendel, is selling vacant assets is absolutely part of our business. We go through an asset management analysis where we try to figure out what is the most economic – what is the most positive outcome in terms of the economics of selling the asset, re-leasing the asset, repositioning the asset or entering into a negotiation with the existing client. And once we sort of go through that, we make the determination to go down one of these paths. And that’s what drives our thinking in terms of how we decide whether to sell vacant assets or occupied assets. And that will continue to be the mantra that dictates our asset management strategy going forward.

[Haendel St. Juste, Mizuho]

Got it. Got it. That’s helpful. Maybe some comments on business – thinking of business overall, I understand you’re not in a position of having to sell assets, but just curious if you’re maybe thinking a bit differently here, maybe selling a bit more in light of the movement in rates?

[Sumit Roy, President and Chief Executive Officer]

So Haendel, do you think what we’re experiencing today is going to continue on? Because, yes, if what we have experienced in the market more recently sort of creates this disconnect between private market valuations and public market valuations, and obviously, selling assets becomes very much part and parcel of our strategy. Truth be told, Haendel, we’ve never, outside of those very small pockets of time, i.e., when the pandemic first started, where we had a few weeks where there was a dislocation. For a sustained period, we’ve never encountered a scenario where asset prices were being valued in the private market higher than what our public market valuation indicated. But if that were to play out, hypothetically speaking, we would not be averse to raising capital, if needed, through asset sales. This is, again, I think, will accrue to our benefit given the quality of assets that we have being able to assemble especially over the last 10 years, and more specifically, over the last 3 to 4 years. So that continues to remain a strategy but one that we hope doesn’t play out because I think the only scenario where I can see that happening is a macro environment where things are incredibly uncertain. And I hope that, that doesn’t play out that way. But look, it’s absolutely a theoretical strategy that we can lean on if needed.

[Haendel St. Juste, Mizuho]

Got it. Got it. One more on the guidance, maybe for Christie, you reversed the $10 million of movie-theater-related reserves. I’m curious what’s left that opportunity bucket here today and what’s contemplated in the guide. And maybe a question on the lower end of guidance, run-rate FFO was closer to $0.95. You didn’t raise the lower end. Maybe help us square that a bit? Thanks.

[Christie Kelly]

Yes. I think certainly, Haendel, I mean, in terms of the overall reserves that we have remaining from the COVID time period, it’s approximately $30 million. And the majority of those deferral arrangements are going to be in effect as of July. And so in accordance with our guidelines and the like, we will be ensuring over the next 6 months towards the end of the year that we’re collecting in accordance with our deferral arrangements. And so as it relates to guidance, we really don’t have anything else factored in of note into the midpoint of our guidance.

[Haendel St. Juste, Mizuho]

Okay, thanks.

[Operator]

Okay, we will move to our next question. Caitlin Burrows with Goldman Sachs. Your line is open.

[Caitlin Burrows, Goldman Sachs]

Yes. Great. Maybe on the tenant side, Sumit, earlier, you referenced it briefly, but obviously, you have a lot of individual tenants. What’s your impression on how they are doing? To what extent they can pass along inflation impacts to their customers? And how that ultimately impacts their ability to pay rent?

[Sumit Roy, President and Chief Executive Officer]

Yes. Look, it is certainly a story that is playing out very differently for those that are well-capitalized businesses versus those that tend to be smaller operators in this high inflationary environment. We had Neil’s team, the research team, do an analysis on our top 150 clients. And they represent about 85% of our rent. And we were like very focused on what is going to happen to their balance sheet, their ability to pay in the event that interest rates were to rise 300 basis points from where it is currently. And, this is a big and, they didn’t have the ability to pass through any of those increased costs that they were bearing on to their customers, which is a highly unlikely scenario, but we were trying to figure out what would happen in that particular scenario for us. And it was 11 of these operators of the 150 representing less than 5% of our rent where the coverages fell below 1x. So, we feel like – again, by design, we have created a client registry that’s predominantly made up of very well capitalized operators. But those one-off operators – and Caitlin you are right, we have 1,000 different clients. So, we certainly have a few one-off operators that tend to be smaller operators. It is going to be more difficult for them to be able to absorb this and their inability to pass through their costs. But we have had a few general merchandising stores. We have had a few folks who are going to – who have actually talked about increasing EBIT margins because of their ability to pass-through a lot of these costs. And predominantly, our client registries made up of those types of folks. So, yes, hypothetically, Caitlin, the smaller operators will suffer in this environment and may not make it. But thankfully, we don’t have too much exposure to that, and it is very small in terms of percentage of our overall rent.

[Caitlin Burrows, Goldman Sachs]

Great. Thanks. And then maybe just as a follow-up to an earlier question regarding that $45 million to $55 million of VEREIT-related G&A synergies. Christie, could you just clarify to what extent Realty Income is already at a good run rate, or how much further there is to go when you think I will get there, just trying to think of the cadence and timing there?

[Christie Kelly]

Yes. I think, Caitlin, we are already over the midpoint of our guidance for the first year of execution. And to that point, we probably have 10% to 15% more to go. There is essentially some lag associated with timing that will also spill into 2023, but we have made excellent progress as a team.

[Caitlin Burrows, Goldman Sachs]

Thanks.

[Christie Kelly]

Thanks Caitlin.

[Operator]

Next we will go to Ronald Kamdem with Morgan Stanley. Your line is open.

[Ronald Kamdem, Morgan Stanley]

Yes. A couple of quick ones for me. Just going back on sort of the gaming acquisition, I think you have mentioned in the opening comments still on track. Can you remind us what else sort of needs to be done before that’s done and dusted? And the follow-up is just, have you sort of gotten – received more interest in sort of the gaming side? And is that an opportunity? Thanks.

[Sumit Roy, President and Chief Executive Officer]

Hi Ron. Yes. So, the biggest element to closing this transaction is the licensing process, and we are well in the midst of going through that process. We have submitted our application. It is being reviewed by the Massachusetts Gaming Group. And we are very hopeful that by fourth quarter, we will be in a position to close this transaction. But that really is the one outstanding element to be able to close this transaction, but so far so good. Everything that we are hearing, everything that we have received in terms of MGC’s response to our initial application has been quite positive. So, we feel pretty good about that. In terms of the industry itself, no surprise, we are getting a lot of inbounds from potential sale-leaseback opportunities. And the team is reviewing them one at a time. But our thesis around this particular space remains the same. We want to partner with the best-in-class operators and find assets that are truly one-of-a-kind, just like we did with the Boston asset. And if at a very high level, those criterias are met, we will absolutely continue to increase our exposure to this particular sector.

[Ronald Kamdem, Morgan Stanley]

Great. And if I could just sneak in one more. Just earlier in the call, you made some comments about sort of the top 150 tenants in the portfolio and 85% of rents. And when I think about aspirations of doing these larger sale-leaseback opportunities, just you take a step back, how many of those clients potentially do you think are – would be interested this would be the right solution for them versus it sort of have to be new relationships, new tenants for sort of these larger sale-leaseback deals in the future? Thank you.

[Sumit Roy, President and Chief Executive Officer]

Sure. So Ron, I mean you have seen us grow our existing relationships to areas where they start to dominate our shareholder registry. So, for instance, I will give you a perfect example. We did the first sale-leaseback with Dollar General. This was, I believe in 2015- 2016 timeframe, and it was maybe $130 million, $140 million sale-leaseback. We subsequently continued to grow our opportunity with Dollar General through multiple sale-leasebacks. It’s a similar story with 7-Eleven. A lot of these clients that you see in our top 20 have grown over multiple years and they continue to have ambitious growth profile. So, that channel of growth remains for us. Then we also have the ability to do first-time sale-leasebacks in a large way with clients like Wynn. These are asset classes that tend to be very large. But again, given that we are about a $57 billion, $58 billion company today, it is going to register as a 3.5% client. And clearly, we have said this very openly that in the event, Wynn decides to continue to execute and grow their footprint beyond the two locations that they currently have, we would love to continue to partner with them. And so this is a function of being able to do first time sale-leasebacks in a big way. And now that we are of the size that we are, our ability to absorb those – and when I say big, I mean $1 billion sale-leaseback, even multiple billion dollar sale-leasebacks that has grown over the last few years and especially post the VEREIT merger.

[Ronald Kamdem, Morgan Stanley]

Helpful. Thank you.

[Sumit Roy, President and Chief Executive Officer]

Sure.

[Operator]

Next we will go to Joshua Dennerlein with Bank of America. Your line is open.

[Joshua Dennerlein, Bank of America]

Yes. Hey everyone. Sumit, just wanted to follow-up on your comment that cap rates tend to lag, interest rate moves by six months. So, I guess why not maybe slow down acquisitions a bit and kind of weight maybe towards the back half of the year to kind of get that better cap rate?

[Sumit Roy, President and Chief Executive Officer]

Yes. Hi Josh. I wish our business was a spigot where you could switch it off and turn it back on at a moment’s notice. Unfortunately, our business doesn’t work quite like that. When you think about how we source opportunities and how we create a pipeline of opportunities and what is the timing that it takes from making a decision to pursuing a particular transaction and then closing it, it could take anywhere between four months to six months from start to finish. So, unless you have a crystal ball, it is very, very difficult to be able to sort of do exactly what you suggested, which would have been perfect, if we could. The other thing I would tell you is there is a lag even in our cost of capital. When you have volatile situations like this, but you are seeing opportunities that seem very well priced on a pure real estate underwriting in terms of replacement costs, in terms of price per pound, and you think about the leases that we are able to capture with the clients that are engaging in these types of transactions, you obviously build into your underwriting a particular buffer. And hopefully, we have been conservative enough where we are still being able to capture positive healthy spreads to our cost of capital while continuing to enhance the – our basic AFFO per share growth as well as our client registry with new relationships. So, it’s very difficult. We had a different mindset over the next six months to nine months, which said, hey, the world is going to fall apart. We absolutely will pull in our horns just like we did in that very first quarter right after the – it was actually the second quarter of 2020, when the pandemic hit where we slowed down our ability to sort of continue looking at transactions, and truth be told, even the market there, the transaction market sort of went silent for a bit, just because people are very unsure of how things are going to play out. But that I have already shared with you is not the case. Sourcing remains very healthy. And we feel like even with the appropriate flexing of our own cost of capital, we are able to grow our business in a manner that is very much aligned with our acquisition strategy. But Josh, I will be very honest, if our views change, we will stop continuing to build the pipeline. But that is not the case right now.

[Joshua Dennerlein, Bank of America]

Okay. That’s fair. And then maybe another follow-up about expanding into other countries in Europe, what is it that get you comfortable to expand outside the UK and Spain?

[Sumit Roy, President and Chief Executive Officer]

The right opportunities. There are already a set of countries that we have preapproved, so to speak, internally and have shared with our Board that there are countries that we would like to be able to grow in the event the right opportunities come along. We have identified the businesses that we would like to do business with. We have identified the clients. We have identified the fact that these are businesses that will continue to thrive even in cycles like the one that we are experiencing. And if those boxes are checked and we are able to sort of strike the right balance in terms of spreads, etcetera, that’s what’s going to allow us to continue to expand our geographic footprint in Western Europe.

[Joshua Dennerlein, Bank of America]

Great. Thanks guys.

[Sumit Roy, President and Chief Executive Officer]

Thank you, Josh.

[Operator]

Next we will go to John Massocca with Ladenburg Thalmann. Your line is open.

[John Massocca, Ladenburg Thalmann]

Good afternoon.

[Christie Kelly]

Hi John.

[John Massocca, Ladenburg Thalmann]

So, I think historically, you have kind of looked at long-term same-store growth. I understand you have a target for guidance this year. But long-term same-store growth is being right around 1%. And some of the things you are seeing in terms of maybe rent on renewals and just the effects of increasing prices across the real estate world, in general, increase that outlook, I mean is that enough to move the needle, or is it just – it’s obviously going to primarily be the rent bumps you have in place. But I mean can that be big enough given the lease expiration schedule to move that up maybe noticeably?

[Sumit Roy, President and Chief Executive Officer]

Well, John, that’s what makes us different, right. I mean if you look at our world, vis-à-vis our peers, we are at right around 8 years, 8.5 years. And if you look at our lease maturity schedule and I think I said this during my prepared remarks that 12% of our leases are going to renew over the next 2.5 years. And so it does – if we can keep this momentum, I don’t know if it will be 106%, but the other thing I would say about that 106% is it’s effectively net increases. And so if we can keep it in that ZIP code, that will become a major growth driver for our business, and it will become an internal growth driver of our business, especially if we continue down this highly inflationary environment. The other good news is if you think about our international expansion, a lot of those leases tend to be CPI-adjusted leases. And they don’t tend to have this collar – a ceiling and a floor that we experience here, but it’s a relative comment. I would say the vast majority of CPI leases that we have here in the U.S. tend to have a collar. And I would say maybe one-third to even 40% of the leases in the international markets tend to be – basically do not have a collar around it, and they are very much tied to CPI growth. And so I think all of that will start to percolate through our portfolio and will help us drive more internal growth than what we have historically experienced in our business. And we think of this as an opportunity, and we have been talking about asset management now for about 5 years, 6 years in anticipation of what we are now starting to experience as a company. And so look, we think we are very positively set up to take advantage of this situation. And it then helps us alleviate some of the pressure of just growing through external measures, which of course, is also something that the team is doing very well.

[John Massocca, Ladenburg Thalmann]

And then on the external growth side of things, obviously, you are a bigger company, so you would expect this to grow. But the development pipeline seems to kind of keep taking legs up. I mean is there something specific driving that?

[Sumit Roy, President and Chief Executive Officer]

Yes. It’s by design, John. We want development to continue to tick up because we do get more spread doing development. And this allows us to continue to be the one-stop solution that our clients are looking for. And just to be super clear, we are talking about build-to-suit on 99% of our development. So, I mean…

[John Massocca, Ladenburg Thalmann]

Are you talking about client demand, or is that something just you haven’t been exploiting that market maybe 3 years ago the same way you are today?

[Sumit Roy, President and Chief Executive Officer]

John, they are build-to-suit. So, by definition, they are being driven by our clients coming to us or coming to a developer and saying we would like to have you develop here in this particular location because we would like to enter into a long-term lease. And we have either relationships directly with our clients who then ask us to work with the developer or with some developers who have asked us to become their capital source as a permanent takeout. And that is what’s allowing us to continue to enhance our development pipeline. So, this is absolutely being driven by the clients, not by us. This was just a hole in our overall strategy that we are now addressing in a meaningful way.

[John Massocca, Ladenburg Thalmann]

Okay. That’s it for me. Thank you very much.

[Sumit Roy, President and Chief Executive Officer]

Thanks John.

[Operator]

Next we will go to Linda Tsai with Jefferies. Your line is now open.

[Linda Tsai, Jefferies]

Yes. Hi. In terms of driving higher internal growth that you just mentioned, is there a range you would like to target or move towards over time?

[Sumit Roy, President and Chief Executive Officer]

10%. Linda, I am not trying to be flippant, but look, our intention is to try to drive that up. Some of it will naturally come with the expansion in asset types. There are certain asset types that lend themselves to higher organic growth. That was part of the attraction that we had with investing in industrial assets, and we saw that. And some of these other asset types, just like I said, do have a higher profile than the 1% that we have traditionally been able to get in the space that we had targeted historically. So, could I see that tick up, that’s the hope with more international acquisition, with more industrial, with more development where we can create more bespoke leases. If we can get that 1% to 1.5% to 2%, that would be a major uplift and a source of internal growth. But that’s not going to happen overnight. It’s going to take us time, and it’s going to take intentionality, which we certainly have.

[Linda Tsai, Jefferies]

Thanks. And then just to follow-up, any general update on the theater business? To the extent you have seen more recovery, would you look to sell some of these assets?

[Sumit Roy, President and Chief Executive Officer]

We are not quite there where we would want to sell our theater portfolio, Linda. In fact, all indications have been all trend lines have indicated that the theater business is getting back to a strong footing despite all of the noise that we hear about the theater business and PBOD [ph] and all of that. In fact, I was looking at some numbers in the first quarter of 2022. We are back to about 75% of 2019 levels. And so clearly, this is a business that is largely driven by content. We are also very encouraged by the pipeline of big-tent movies that are going to be released over the next two months to three months. We are very hopeful that, that will translate to more attendance. And the good news is a couple of these large operators like Regal and AMC are cash flowing positive on the assets that we own. So, I think all of that leads us to believe that this industry as we had hoped and our hypothesis was is sort of on demand. Having said all of that, we also did a fair amount of downside scenario analysis where we looked at some of these locations and we feel like we have the ability, the capital, the relationships to reposition these assets in the event that the business doesn’t play out. I think the wrong economic decision today would be to sell some of these assets at what I would consider to be fire sale prices. And again, just to remind everyone, 82% of our portfolio is in the top two quartiles of performance for both these operators. So, we feel very good about the theater business, but more specifically about the portfolio that we own. And so the decision to sell, though a theoretical one and has been considered, is one that we are not in a position to execute on given some of what I just said.

[Linda Tsai, Jefferies]

Thank you.

[Sumit Roy, President and Chief Executive Officer]

Thank you.

[Operator]

This concludes the question-and-answer portion of Realty Income’s conference call. I will now turn the call over to Sumit Roy for any concluding remarks.

[Sumit Roy, President and Chief Executive Officer]

Thank you all for joining us, and we look forward to speaking at the upcoming NAREIT conference. Thank you all. Bye-bye.

[Operator]

This concludes today’s conference call. You may now disconnect.