Realty Income Corp

NYSE:O

Earnings Call Analysis

Realty Income's Strong Q2 Performance and Strategic Investments

Realty Income reported a strong second quarter, with AFFO per share growing 6% to $1.06, driven by keen investments in the U.S. and Europe, totaling $805.8 million at an average initial cash yield of 7.9%. The company increased its full-year investment guidance to $3 billion—up 50% from prior guidance—reflecting a growing pipeline of attractive opportunities. With transaction volume rising $200 million sequentially, Realty Income is well-positioned to deliver on its AFFO per share guidance of $4.15 to $4.21 for 2024. Despite headwinds including certain client bankruptcies, the company remains confident in achieving nearly 1% same-store rental revenue growth for the year.

Strong Operational and Financial Performance

Realty Income demonstrated strong operational and financial performance in the second quarter of 2024. The company reported AFFO per share of $1.06, marking a 6% increase from the previous year. This, combined with an annualized dividend yield exceeding 5%, provided shareholders with an impressive total operational return of over 11%. The company's portfolio performance remained robust, with occupancy rates increasing to 98.8% as of June 30, reflecting a 20 basis point increase from the prior quarter, and rent recapture rates at 105.7%, contributing approximately $34 million in new annualized cash rent.

Investments and Growth

Realty Income made significant investments totaling $805.8 million across the United States and Europe in diversified sectors like retail, industrial, and data center real estate. The investments were secured at a blended initial cash yield of 7.9%, or 8.2% when assuming a CPI growth of 2%. Specifically, $262 million was allocated in the U.S. at a 7.6% yield, and $544 million in Europe at an 8% yield, which included a notable $377.5 million investment in a secured note issued by the U.K. grocery operator, Asda, at an 8.1% yield.

Strategic Credit Investments

The company continued to strategically pursue credit investments that facilitate access to high-quality real estate opportunities, exemplified by the investment in Asda. These investments also act as a natural hedge to interest rate risks on the liability side of the balance sheet. The company's disciplined transaction approach earlier this year paid off, leading to a $200 million increase in transaction volume sequentially, prompting an investment guidance increase to $3 billion by June, a 50% rise from previous guidance.

Capital Management and Cash Flow

Investment activities were primarily funded by adjusted free cash flow totaling approximately $200 million in the quarter. This approach negated the need for public equity reliance, enhancing the accretive nature of these transactions. Realty Income's goal is to utilize excess free cash flow alongside its portfolio's internal rent growth to deliver an approximate 7%-8% annual total operational return to shareholders, without public equity issuance. The portfolio's stabilized internal growth rate has increased to 1.5% annually, attributed to the expansion into European markets and sectors with favorable lease structures such as gaming and data centers.

Risk Management and Asset Dispositions

In the second quarter, the company disposed of 75 properties, totaling net proceeds of around $106 million, bringing the year-to-date total to approximately $202 million. Realty Income plans to sell between $400 million and $500 million in assets for the year. These dispositions, informed by proprietary analytic tools, have become a more active part of the company’s strategy. This disciplined approach helps optimize portfolio composition and fund growth through organically generated capital.

Balance Sheet Strength

Realty Income maintains a strong balance sheet with low leverage, holding A3/A- credit ratings by Moody's and S&P. In the second quarter, the company repaid $350 million of maturing public notes, leaving only $118 million of maturing mortgage debt for the year. Liquidity remains solid with access to approximately $3.8 billion of capital, inclusive of cash on hand, credit facility availability, and outstanding ATM forward equity. The company reiterated its full-year investment guidance at $3 billion and AFFO per share guidance of $4.15-$4.21, representing a 4.5% annual growth at the midpoint.

Outlook and Market Conditions

CEO Sumit Roy noted signs of market normalization with more high-quality investment opportunities aligning with cost of capital. The stable and diversified global real estate portfolio of Realty Income continues to provide excellent revenue visibility and has avoided any year of negative operational return in its 30 years as a public company. The company remains vigilant in managing interest rate risks while leveraging improving cost of capital to stay competitive. Future actions will be driven by market conditions and the materialization of beneficial transactions.

Guidance and Future Plans

Looking ahead, Realty Income aims to remain disciplined despite an improving cost of capital environment, focusing on high-return investments and credit opportunities. The company is not anticipating more credit investments in the latter half of the year. Real estate investments will dominate upcoming activities, with a particular focus on sectors and regions providing higher yields. The firm’s strategic focus includes potential larger portfolio deals in the second half of the year, though market conditions will ultimately dictate activity levels.

Earnings Call Transcript 2024-Q2

[Operator]

Good day, and welcome to the Realty Income Second Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Steve Bakke, Senior Vice President, Corporate Finance. Please go ahead.

[Steve Bakke, executive]

Thank you all for joining us today for Realty Income's Second Quarter Operating Results Conference Call. Discussing our results will be Sumit Roy, President and Chief Executive Officer; and Jonathan Pong, Chief Financial Officer and Treasurer.

During this conference call, we will make statements that may be considered forward-looking statements under federal securities laws. 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. [Operator Instructions].

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

[Sumit Roy, executive]

Thank you, Steve. Welcome, everyone. In the second quarter, I'm pleased we were able to deliver strong results as the economy as well as the transaction market navigate today's rate environment. We seek to be real estate partners to the world's leading companies and the diligent efforts of our dedicated team resulted in AFFO per share of $1.06, representing a robust 6% growth compared to last year.

Combined with our annualized dividend yield in excess of 5%, our shareholders earned a total operational return of over 11%. The power of our global sourcing and acquisition platform was on display this quarter as we deployed capital in the U.S. and Europe across retail, industrial and data center real estate and the real estate-backed credit opportunities. In total, we invested $805.8 million into high-quality opportunities at a blended 7.9% initial cash yield or an 8.2% straight line yield assuming CPI growth of 2%. Of this, approximately $262 million of volume was invested in the U.S. at a 7.6% initial cash yield. The balance of approximately $544 million was invested in Europe at an 8% initial cash yield, including a $377.5 million investment in a secured note at an 8.1% yield issued by Asda, a leading U.K. grocery operator.

As we discussed in the past, we intend to pursue credit investments selectively and only when it may eventually facilitate access to high-quality real estate opportunities as has been the case with Asda. We also believe these credit investments represent a profitable means for Realty Income to participate in and benefit from the current rate environment.

Furthermore, from a risk management perspective, we view these credit investments as a prudent natural hedge to the inherent rate exposure as we have on the liability side of our balance sheet. Providing further detail on investments in the quarter, we executed 79 discrete transactions with 55 clients, including 2 new clients across 22 industries. 31% of direct real estate investment volume was allocated to new sale leasebacks. Touching on our sourcing activity. We were pleased that our transaction discipline earlier this year is bearing fruit. As this quarter, we began to see a greater number of opportunities available at pricing that aligns with our cost of capital. This improvement supported the $200 million increase in transaction volume sequentially and it drove the investment guidance increase to $3 billion in June, a 50% increase from our prior guidance.

We believe the higher closed volume paired with investment spreads that are largely consistent with last quarter, or sign the transaction market may be moving towards normalization. Investment activity this quarter was funded in large part by adjusted free cash flow, which totaled approximately $200 million in the second quarter. Not having to rely on public equity enhance the accretive nature of these transactions. The deployment of excess cash flow represents an important contributor to our growth.

In fact, we believe we can utilize excess free cash flow together with our portfolio's internal rent growth to deliver an approximate 7% to 8% total operational return annually to shareholders without relying on public equity issuance. The portfolio's stabilized internal growth rate has risen in recent years and now stands at approximately 1.5% on an annualized basis. In part because of the expansion of our European platform, where many leases are subject to uncapped CPI increases as well as our expansion into the gaming and data center vertical, which -- where leases often include healthy annual rent escalators.

With the benefit of excess free cash flow, second quarter capital deployment activity resulted in an investment spread of approximately 293 basis points, which like the first quarter is well above our historical spread of 150 basis points in part due to the utilization of excess free cash flow. As a reminder, these disclosed investment spreads utilize our short-term nominal cost of capital which measures the estimated year 1 earnings dilution from raising capital on a leverage-neutral basis to fund our investment volume. This is different from a higher long-term cost of capital, which applies a growth premium to our cost effectivity to account for the long-term return requirements for our investors. While we remain vigilant in today's volatile environment, seeking only the most attractive risk-adjusted return opportunities. We will also only utilize external capital opportunistically, aiming to augment our growth rate at times when our cost of capital becomes increasingly attractive as compared to prevailing market investment yields.

An additional source of capital in the second quarter was dispositions. We've utilized proprietary predictive analytic tools in combination with the insights of our asset management and research teams, to drive the decision to sell 75 properties for total net proceeds of approximately $106 million, bringing the year-to-date total to approximately $202 million. For the year, we expect to sell between $400 million and $500 million of assets. As we continue to calibrate and hone our predictive analytic tools, advancing our investment thesis on each property in our portfolio we may be more active on dispositions than in the past. We continue to optimize our portfolio composition and investment returns while broadening our use of organically generated capital to finance growth.

Another critical point of differentiation for Realty Income is the strength of our balance sheet, underpinned by our low leverage of A3 A- credit ratings by Moody's and S&P, respectively, and our access to capital on a global basis. During the second quarter of 2024, the combination of internally generated cash flow and disposition sale proceeds allowed us to fund most of our investment activity without settling any newly issued equity capital while still maintaining our leverage metrics at or below our long-term targets.

Shifting to operations. Our portfolio continues to generate very solid returns and to perform in a very stable fashion. Occupancy rose to 98.8% as of June 30, a 20 basis point increase from the prior quarter. Additionally, our rent recapture rate across 199 leases was 105.7%, totaling approximately $34 million in new annualized cash rent. The size, scale, diversification and consistency of performance from our global real estate portfolio continues to provide us with excellent visibility to revenue and is a key reason why we have not had a single year of negative operational return in our 30 years as a public company.

Managing through periodic store closures is a natural part of our business model and a top-tier credit research and asset management teams offer distinct competitive advantages, which have consistently enabled us to optimize value in these situations. To that end, we would like to provide remarks on a few clients that are currently managing through store closures or have been in the news due to credit-related concerns.

Importantly, in the context of our portfolio's size and scale, the aggregate financial exposure of potential loss rent is not expected to materially impact our ability to generate the consistent operational returns our shareholders are accustomed to. And it is important to emphasize our recent increase in earnings guidance takes all credit considerations into account. Rite Aid, which represents 30 basis points of our total portfolio annualized contractual rent as of June 30, 2024, is expected to emerge from bankruptcy in the third quarter. Through the remainder of the bankruptcy process, we expect to lose 12 basis points of rent prior to the resolution of assets vacated in the proceedings, which are ultimately released or sold.

Red Lobster represents 1% of our total portfolio annualized contractual rents and it is currently moving through the bankruptcy process. At present, as publicly stated, Red Lobster is targeting to emerge from bankruptcy in the third quarter of 2024. We continue to believe that our visibility into rent coverage and our master lease structure across most of our properties mitigate some of our potential risk. And while not finalized, we currently believe our recapture rate will be roughly in line with our historical portfolio-wide average of 84% for client bankruptcy restructurings.

Walgreens is considered closing certain stores. Looking out over the next 2.5 years, we have leases representing only 26 basis points of our total portfolio, annualized contractual rent that will expire over that time. Outside of a bankruptcy scenario, which we view as unlikely with Walgreens, these are the only stores Walgreens can legally seize contractual rent payments on once each lease expires. To provide context on historical capture rates in the drugstore industry. We have managed 166 lease expirations since 2013. 80% of these were renewed that resulted in a blended recapture rate in excess of 100% of prior rent.

Dollar Tree, which is investment-grade rated announced the potential split of the Family Dollar brand from Dollar Tree. If this were to result in store closings, Family Dollar leases representing only 5 basis points of our total portfolio annualized contractual rent are set to expire between now and year-end 2026. And of course, in the interim, they're obligated to continue paying rent through lease expiration. Our historical recapture results in the Dollar store industries have been similarly favorable. We have managed 263 lease expirations since 2013, of which 86% of the clients renewed at a weighted average rate well north of 105%.

In case of our theater exposure, we feel the risks have notably diminished in the past 12 months. Cineworld reduced its debt by $4.5 billion through its restructuring and AMC recently made improvements to its financial position by extending debt maturities and additional equity issuance. It is important to note that in total, the rent at risk from Rite Aid, Red Lobster, Walgreens, Dollar Tree as well as at home and big lots, which is 11 basis points of rent represents, in total, only 2.3% of our total portfolio annualized contractual rent through year end 2026. And if we achieve the recapture rate in line with our long-term average for bankruptcies, which is 84%, this suggests only approximately 37 basis points of rent is at risk of ceasing or an approximately $0.02 of AFFO per share impact.

In addition, if they do take place, advanced notice of potential store closures are of incremental value to us because they provide years in many instances, to plan the optimal outcome of those locations where the clients plan is to lead, while we continue to be paid rent. This $0.02 per share potential impact is manageable and is counterbalanced by the power and stability of our net lease business model, which is underpinned by diversification across more than 15,000 properties, 1,500 clients and 8 countries on 2 continents. Hence, we believe it is important to separate the store closing headlines from the manageable impact they have on our financials.

With that, I would like to turn it over to Jonathan to discuss our second quarter financial results in more detail. Jonathan?

[Jonathan Pong, executive]

Thank you, Sumit. Consistency has long been a benchmark by which we manage our business. To that end, we ended the second quarter with leverage at 5.3x without settling any ATM equity during the quarter. This was the 25th consecutive quarter of leverage at 5.5x or lower, reflecting our commitment to our A3 A- credit ratings, which we have had now since 2018. As a reminder, we manage our leverage through the lens of net debt and preferred equity to annualized pro forma adjusted EBITDA.

During the second quarter, we generated approximately $200 million of adjusted free cash flow over $100 million in real estate sales proceeds and approximately $185 million, afford unsettled equity sold through the ATM after modest ATM issuance activity subsequent to quarter end, we currently have almost $450 million of unsettled forward equity, which we estimate will be more than sufficient to finance our equity needs for the remainder of 2024 and still remain within our target leverage ratios.

Our balance sheet remains healthy with a well-staggered debt maturity schedule that allows us to be active should borrowing costs trend lower over the maturity cycle. Last month, we repaid $350 million of maturing public notes, leaving us with only $118 million of maturing mortgage debt for the balance of the year. Our exposure to staggered debt of $1.6 billion remains modest at only 6.3% of total debt principal at quarter end, and our liquidity remains solid with access to approximately $3.8 billion of capital at the end of the second quarter, inclusive of cash on hand, availability under our $4.25 billion revolving credit facility and our outstanding ATM forward equity.

We remain comfortable with the liability side of the balance sheet and believe we are well-positioned to act on larger investment opportunities should they present themselves. As Sumit mentioned earlier, we view our credit investments as a natural hedge to the inherent interest rate risk associated with debt maturities we have on our balance sheet. That end, a 6-year GBP 300 million sterling senior secured loan we invested in during the quarter provides us with an attractive 8.1% yield, secured by the solid credit of a U.K. grocery store operator, while reducing the rate sensitivity on the value of sterling debt we have on the balance sheet maturing in 2030, which currently totals GBP 540 million. From 2024 earnings guidance perspective, we are reiterating our full year investment guidance at $3 billion and our AFFO per share guidance of $4.15 to $4.21, which represents 4.5% annual per share growth assuming the midpoint.

As a reminder, we increased our guidance on June 4, which included the expectation of collecting the $16 million of lease termination fees that we recognized in the second quarter. Offsetting a portion of the AFL tailwinds from termination fees was the recognition of approximately $6.2 million of AR reserves from one of our clients in the convenience store industry. Lease termination fees are excluded in our same-store rental revenue calculations, while AR reserves are included and thus the $6.2 million of reserves that we recognized on 1 client in the quarter alongside impact from our theater portfolio, pulled back our second quarter same-store rent growth by approximately 60 basis points, resulting in overall same-store growth of 0.2% for the quarter. Including this reserve, we continue to expect our full year same-store rental revenue growth recovered to close to the 1% level for 2024.

With that, I'd like to hand the call back to Sumit for closing remarks.

[Sumit Roy, executive]

Thank you, Jonathan. To conclude our prepared remarks, the year is progressing largely in line with expectations, perhaps even slightly ahead. There are signs that transaction market is beginning to normalize as we find more opportunities to deploy capital into high-quality investments, meeting our minimum return requirements. Adjusted free cash flow and dispositions continue to be accretive sources of capital we can use to support future growth. Combined with the stability of our solidly performing client base and the strength of our balance sheet, we believe we are well-positioned to deliver attractive risk-adjusted returns to shareholders in a variety of economic environments.

I'd like to now open it up for questions. Operator?

[Operator]

The first question comes from Michael Goldsmith from UBS.

[Michael Goldsmith, analyst]

The largest component of your investment volume this quarter was the investment in the Asda notes. How should we think about the different investment buckets that you have when it comes to expectations for the back half of the year?

[Sumit Roy, executive]

Thank you, Michael. That's correct. We did have a $377 million investment in the Asda loan, which was very opportunistic, and we've already highlighted the reasons as to why we did that. What you should expect for the balance of the year for the remaining half of the year is that we are probably going to have the majority of our investments, if not 100% of our investments in our more traditional investment asset level portfolio level real estate, direct investment. That's what's going to make up the balance of the remaining 6 months.

[Michael Goldsmith, analyst]

Got it. And then as a follow-up, can you talk a little bit about the opportunities you're seeing in the U.S. versus European markets outside the loan, you leaned a little bit more to the U.S. in the second quarter or a reversal from the first quarter. So can you talk a little bit about what you're seeing in these markets and the spreads in the U.S. versus Europe?

[Sumit Roy, executive]

Yes. So we had -- during the first quarter, we had said that we were starting to see some green shoots here in the U.S. where sellers were starting to realize the higher cap rate environment was here to stay. That obviously resulted in an increase in volume in terms of investments here in the U.S. in the second quarter. We expect that to continue into the remainder of the year. The volume increase that we saw with regards to sourcing will also attest to that phenomenon. And I think with the backdrop that we are seeing on the cost of capital side, I do think that there will be more transactions that will materialize in the next half, especially here in the U.S.

The markets in Europe are -- have been fairly stable. I think the expectations of the interest rate cuts were well understood. And what we saw in the first quarter where we had some opportunistic sellers come to the market, and we were the beneficiaries of those transactions. Similar transactions took place in the second quarter. And we feel pretty confident that, that trend will continue for the remainder of the year. But you should see an increase in volume coming from the U.S. and more of the same in markets outside the U.S.

[Operator]

The next question comes from Joshua Dennerlein from Bank of America.

[Joshua Dennerlein, analyst]

Maybe just going back to the Asda loan. I think you've done some other loans in the past that were pretty sizable. Just kind of how do you think about like the duration risk and just like when you're typically taking the equity stake and doing a real estate loan, it's like you'd assume that real estate forever, but for a loan, it's kind of limited duration. Like how does that factor into your underwriting? Just like is there a limit maybe on exposure you want to have for lending?

[Sumit Roy, executive]

Yes. So Joshua, we've been very clear with the market that the credit investment side of the business is an addendum to what we are offering our clients. We believe that opportunistically, it makes a lot of sense for us to continue to be a partner to our clients, such as Asda. And when you look at the investment we made, $377 million at an 8.1% 6-year paper and you overlay the fact that we have maturing debt close to GBP 600 million coming due in about the same time frame, this is one of the reasons why we did what we did. Let me put this in perspective in a slightly different way. If we were to go out and try to do a sale leaseback on Asda Real Estate today, it would probably be in the mid-6s, maybe even in the slightly inside of that. And so for the same credit, if you're able to get 160, 170 basis points of additional spread over a 6-year period. I think it's -- and get the same exposure in terms of the credit. It's something that for us made a lot of sense.

The other reason is one that we've continued to share with the market around why we have gone down this path of credit investments. We've always felt like, okay, we want to be long-term partners to some of our clients. We are willing to do 20-year paper sale leasebacks on their real estate. We are along the credit. We like the credit and if we can continue to create an even closer relationship by participating, higher up on the capital stack, that is something that makes a lot of sense for us. Especially when you take it in the context stuff, we are experiencing the negative impact of higher interest rate environment on our own balance sheet. And if we can offset using this credit investment as a tool, this negative impact that we experienced by participating on the asset side by providing credit to some of our clients then this is a very nice way to hedge this negative impact.

Having said all of this, we've also been very clear that credit investment is going to be a point in time. This is not a tool that will work in every environment, and we don't expect to do credit investments in a very low interest rate environment. And so for all of the reasons that I've just enumerated, it's a wonderful tool to have. And thankfully, we have the relationships with clients who want us to participate, we would like to participate and it acts as a natural hedge to some of the negative headwinds that we encounter in this environment. So that's why we did what we did.

[Joshua Dennerlein, analyst]

Okay. And then maybe just one other question. Just you mentioned the expansion into data centers and gaming. It helps drive internal growth by going into those verticals. I guess are there any other verticals you're looking at or where you think you can get that higher internal growth rate if you're already in that vertical?

[Sumit Roy, executive]

Yes. So the areas that give us that higher internal growth largely are the 2 you've mentioned and the international market. And obviously, this is not a new vertical for us, but industrial does tend to have higher internal growth as well. And the combination of our investments in these areas have resulted in the profile of internal growth changing from circa 1% in our business to 1.5%. And that will continue to be the areas that we focus in, in the future. I think this was a question that was asked in the previous call as well. Are there any new verticals that we are looking at? And the answer is no. We have a very well-defined total addressable market based on the verticals that we've already articulated to the market, and we are very comfortable continuing to play in those specified verticals. And there's plenty to be done. So we're very happy with that.

[Operator]

The next question comes from John Kilichowski from Wells Fargo.

[William John Kilichowski, analyst]

So the amount of IG tenants as a percentage of acquisitions was 10%, which I believe is lower since the third quarter of 2017. Maybe how should we think about that and your appetite to move down the risk curve to generate yields here?

[Sumit Roy, executive]

Yes. I don't necessarily agree with the last comment that you made in your question that John. But I'll go ahead and answer this question around investment grade representing 10% of our investments in the second quarter. We've always been very clear with the market when we've said that we don't target investment grade as a criteria for investment. What we are looking for is are we generating the right yield for the credit risk that we are taking, for the real estate risk that we are taking, et cetera. And the actual ratings of the client is a byproduct of being able to underwrite appropriate risk-adjusted return profile.

And if it so happens that we have clients that are investment grade as a result of that risk-adjusted profile that we are targeting. That's great. But it's not something we specifically look for. Case in point, John, if you look at our portfolio today, there are so many names in our top 20. That just happened to be non-rated. And have they gone through a rating process, they would be investment-grade. Companies like Sainsbury's, Treasury Wine Estates, we have grocers like Publix and Trader Joe's that are not rated today and don't constitute an investment-grade bucket for us, but if they were to be rated, they would be. And so the point I'm trying to make is, it's not something that we target. It's a byproduct of our underwriting, and we are very comfortable continuing down that path.

[William John Kilichowski, analyst]

Understood. And then I guess maybe jumping to bad debt here. On the last call, you mentioned the conservative nature of your bad debt number. I don't believe you provided it, but maybe could you talk about where it is today and if there's upside to your guide here?

[Jonathan Pong, executive]

Yes. So if you just look at what we disclosed in the footnotes of the income statement on the earnings press release or the supplement, you'll see that we've recognized around $9 million on a year-to-date basis in bad debt expense. And so looking at that as a percentage of revenue, it is around 70 basis points or so. Now what we've always said is that historically, we've been roughly in the 35 basis point range as a percentage of revenue with the bad debt expense. And when you strip out the pandemic, it's closer to 23 basis points.

So we're a little bit ahead of that, but a lot of that was related to this $6 million reserve that we did and uptaking on 1 C-store operator, we do not expect the magnitude of that to carry forward into the back half of the year. But there is still a little bit of conservatism there. And I think from our standpoint, even though we feel very good about a lot of these credits. I think in the back half of the year, you can assume that we're assuming something close to what we recognized in the first half.

[Operator]

The next question comes from Haendel St. Juste from Mizuho.

[Haendel St. Juste, analyst]

I guess first question, just a follow-up on the Asda loan. I guess, are there any purchase options or agreements attached to the loans? And I guess I'm assuming these are assets you wouldn't mind owning at some point. And then as part of that, I guess I just want to confirm, based on your comments in the call that we should not anticipate you doing more loan deals in the second half of the year, that there's nothing else from that type of activity embedded in the guide?

[Sumit Roy, executive]

So Haendel, yes, the last comment you made is accurate. We are not anticipating doing any credit investments in the second half but just to be very clear, credit investments is something that we have used opportunistically in the past, and we will continue to use opportunistically going forward. But it is not contemplated that we will do any in the second half. Having said that, you're right, this is a secured bond offering. And so it is the security that we have is obviously a lot of the unencumbered real estate that Asda continues to own. You're also correct in assuming that we are very comfortable going along the credit. You might recall in the third quarter of last year.

We did a fairly large -- I want to say, north of $600 million of sale leaseback with Asda. So this is a credit that we are very comfortable with. We like the operators, we like what they're trying to do with their business. And this is a way for us to continue to strengthen that relationship going forward. But yes, part of what we are trying to do is in the event they decide to go down the path of doing sales leasebacks, we're going to be first in line. There are no guarantees, but we will be first in line for those conversations. And that's exactly the type of position we would like to be in going forward with clients such as this.

[Haendel St. Juste, analyst]

Got it. Got it. Helpful. And one more, if I may. I was intrigued by your comments on the investing landscape today. It sounds like you're seeing more opportunities to fit your buyback given your improved cost of capital and that seems like you're willing to be more active if the right opportunities present themselves. But I guess I'm curious if the lower cost of debt and just improving cost of capital more broadly is perhaps allowing some private competition to rent to the space. So I'm curious if you're seeing any incrementally new competitors or private equity reentering the landscape here?

[Sumit Roy, executive]

Sure. Good question, Haendel. Look, I think it's a little too early, but the reality is that in the event that interest rates do start to come down, private equity that has largely been absent from the market should start to come back in. We are not currently seeing that in the transaction that we are pursuing. We are seeing some institutional capital, I wouldn't call them private equity coming into the market and becoming a bit more aggressive. But it's not prevalent yet. But yes, if the interest rate environment continues to be positive, i.e., rate cuts start to materialize, finding private equity as a competitor is certainly something that we should expect.

You talked about us becoming more aggressive given our cost of capital having improved, especially over the last couple of weeks. That is true. And our cost of capital has improved. But the point I want to keep making, Haendel, is we want to remain very disciplined. We do believe that there will be more transactions that should take place just given the backdrop that we've talked about. But we don't have to do a whole lot to generate the earnings guidance that we've shared with the market. And if the market opportunistically produces transaction for us, that we feel like makes a lot of sense for our portfolio, we will absolutely be first in line to take advantage of that. And that's the position that we want to be in. And -- but I don't think the fact that our cost of capital has improved, that's going to be the impetus to go out there and start doing more transactions.

I think the materialization of actual transactions that we would like to be successful pursuing that is going to drive what we do in the second half. And we feel based on everything that we are seeing, plus the pipeline that we have, very confident that the investment market will continue to improve.

[Operator]

The next question comes from Smedes Rose from Citi.

[Bennett Rose, analyst]

Just going back, I was just wondering about the transaction activity that you kind of had in your pipeline. I mean do you see more kind of larger portfolio deals in the offering? Or is it more kind of smaller kind of one-off transaction opportunities, just any sort of changes since your last quarterly call?

[Sumit Roy, executive]

Smedes, there are some large transactions that will be coming to market in the second half. These are existing clients that we have that we are in constant conversations with as to whether we are lucky enough to win those transactions or whether they actually end up coming to market is still a bit of a question mark. But we are starting to see those types of conversations taking place, and we feel pretty good that the market is going to improve. Our pipeline is largely along the lines of what we've achieved to date on the straight up organic acquisition side. And there aren't any $1 billion portfolio. So that's what you're thinking that we have in our pipeline yet. But the conversation leads me to believe that there will be larger portfolios coming down, but we'll see.

[Bennett Rose, analyst]

Okay. Okay. And then I just wanted to ask you, too, I'm sorry if you maybe address this, but the termination fees you received in the quarter, they were related to one particular client or with a bunch of fees that happen to come in at once. So just kind of wondering what they were related to?

[Jonathan Pong, executive]

Yes, Smedes those related to one particular tenant. And it's really reflective of an agreement that our team was be able to reach with them for a handful of assets, not the entire exposure, but just a handful of them.

[Operator]

The next question comes from Greg McGinniss from Scotiabank.

[Greg McGinniss, analyst]

I hope you're doing well. I was just hoping to get a little more color on how you're identifying assets for disposition, whether that's tenant credit, renewal risk, geography? Any color would be appreciated.

[Sumit Roy, executive]

Sure, Greg. So a lot of it is very -- it's opportunistic. It is an analysis, a very deep analysis that the asset management team takes on looking at assets for existing clients that may not have the right return profile that longer term because the markets have changed, or that particular location is not what it used to be. There could be several reasons as to why they get into the disposition list, 1 of which could be credit as well.

And so we are using our predictive analytic tools to help monitor these 15,000 assets that we have at any given point in time and it's coming out with a rating that then suggests that, hey, this 1 may have a high location risk or low fungibility available to these locations. And then we overlay the credit on top of that. And then asset management goes through those and tries to create various different scenarios of what is the economic outcome going to look like under, for instance, a client that may not have any credit issues will pay rent. But at the end, this asset may not have other alternatives available to it outside of a vacant sale. And that return profile will be compared with selling it today to see what yields a better outcome. And that's the analysis that the asset management team is undertaking far more directly today than I think we've done in the past and that's the reason why we've come up with the $400 million to $500 million of assets that we feel like does not necessarily have a long-term future in our portfolio. And that's how we come up with the list.

[Greg McGinniss, analyst]

Okay. And then on acquisitions, how should we be thinking about your view on investment spread with the improved cost of capital versus what you're actually seeing in the market. The U.S. cap rates were up 70 basis points quarter-over-quarter. Is that kind of a fair target area? Or could we see that start to come back in?

[Sumit Roy, executive]

Greg, as you know, I think I don't see the cap rates moving out from these levels. And in fact, they probably are going to start to come in going forward just given the backdrop that we are all experiencing with better cost of capital, more competitors are going to start to come in. That's going to push -- it's going to put pressure on the cap rates. So -- but in terms of spread, which is how we think of our business, we are very hopeful of maintaining the spreads that we've achieved thus far. And it could be a combination of our improving cost of capital despite perhaps a slightly lower cap rate environment.

But we are going to be very selective in what it is that we pursue, which is why we have not gone out and increased our acquisition guidance. But let's wait and see what happens over the next couple of months. Things are fairly volatile with elections coming up later this year. And obviously, we see what's happening on the geopolitical side. So it is a bit of a volatile period. But having filtered all of that, I think you should expect to see us trying to maintain the spreads that we've achieved thus far.

[Operator]

The next question comes from Upal Rana from KeyBanc Capital Markets.

[Upal Rana, analyst]

Sumit you touched on dispositions already, but I wanted to get your reasoning on providing guidance at this point? And is this a product of better visibility or a shift in strategy you did mention that you do impact and expect to be more active on that front than the past. So you have sold a number of vacant properties already this year, but you still have another 185 more to go. So I want to get any color on that, that would be helpful.

[Sumit Roy, executive]

Yes. Good question, Upal. You should expect the -- at the end of it all, half of it to be occupied assets and half of it to be vacant assets. So clearly, the trend for the first half has been more vacant asset sales. So that's going to shift going forward. It is a slight shift in our strategy, but part of it is driven by 2 very large M&A deals that we've effectuated over the last 2.5 years. And clearly -- and we've been very upfront about this. There are assets that we've inherited that it's not a long-term strategic hold for us. And so we just want to be more proactive in being able to dispose of these assets.

And given the quantum of capital that this particular process can generate for us i.e., $400 million to $500 million, we wanted to be very clear with the market that look, this is going to be a source of capital for us that you may or may not be aware of. And so people can appropriately underwrite that source of capital. And when we make statements like we don't have to be out in the equity market, this helps explain that piece. But the strategic rationale is always are constant vigilance on what is it that our portfolio looks like? Where has our strategic shifts occurred given everything that we are seeing and being a lot more proactive on the disposition side than we had traditionally been.

[Upal Rana, analyst]

Okay. Great. That was helpful. And then you mentioned in your prepared remarks about the transaction market moving towards normalization. What did you mean by that? Did you mean in terms of volume, cap rates investment spreads, seller sentiment, competition? Maybe if you can give more any detail on that, that would be helpful.

[Sumit Roy, executive]

Sure. So obviously, a lot of sellers were on the sideline hoping for cap rates to move, we've always talked about the cost of capital is a mark-to-market variable that's essentially getting marked every second. But cap rates tend to be stickier. And when the cost of capital changed as abruptly as it did for a lot of the REIT sector, the sellers were not able to accept that environment. And so they were waiting on the sidelines, expecting things to change, but sellers can't wait indefinitely.

And we've seen that phenomenon play out in the international markets more so than here. And -- but -- and so when that happens, sellers start to creep back into the market after a period of time. And the added element that's taking place is there's a little bit more clarity today, and I say that and I smile as to where the interest rates are going to go, and so obviously, the cost of capital side of the equation has changed for a lot of the REITs. And so this is going to allow them to transact on transactions on assets that they would have looked at doing had their cost of capital being better. And so I think it's a movement on the buyer side. It's going to be a movement on the seller side. And that's what I mean that this should facilitate more transactions in the second half than it has in the first half.

[Operator]

The next question comes from Linda Tsai from Jefferies.

[Linda Yu Tsai, analyst]

The 1% of same-store revenue growth you're achieving this year. What does it look like for next year if your portfolio stabilized internal growth rate is 1.5% on an annualized basis?

[Jonathan Pong, executive]

Yes. So Linda, first of all, there's some moving pieces with this year's guidance of approximately 1% on same-store. It's a difficult year-over-year comp because we did have some reserve reversals and deferment payments that we realized last year. Last year, we had 1.9% was our same-store number. This year at 2%, you're kind of averaging -- this year at 1%, excuse me, you're kind of averaging outside 1.5% level. And so next year, there should be an easing of the difficult comps, but what we've always been framing for investors, especially more recently is that we are around 1.5% on a contractual rent basis, growth basis. And we would expect that to continue next year and beyond.

[Linda Yu Tsai, analyst]

And then assuming an 84% recapture rate through year-end 2016, you only have 37 bps or $0.02 of AFFO per share impact at risk. Could that mean that your bad debt outlook in '25 is stable or even less than what we saw this year?

[Sumit Roy, executive]

Linda, the way to think about bad debt is we start the year expecting a certain percentage of bad debt expense. And in certain years, we either meet those in a lot of years, we beat them. And in certain other years like the pandemic year, it goes beyond what we had originally gone into the year with. I think this is one of those -- like last year, for instance, we were -- we had positive outcomes on what our initial expectation was, which was, I think, 40, 50 basis points of rent. And all of last year, we not only did not have any bad debt expense, we actually ended up collecting on rents that we had on cash accounting. So that was a positive outcome.

This year, this seems to be trending more in line with what we had anticipated at the beginning of the year. And there is some potential upside, but we are not -- we've still got 5 months left, and we'll see how things play out. But traditionally, it's been right around that 23% absent the pandemic year. And inclusive of the pandemic year, it's been right around 37% -- 37 basis points, sorry, 37 basis points of rent that has basically been bad debt expense. So do we expect 2025 to be similar, yes. But we generally don't talk about years well in advance, which is why I'm pointing to what historically has happened at Realty Income.

[Operator]

The next question comes from Alec Feygin from Baird.

[Alec Feygin, analyst]

Kind of to go back to the C-store client, that litigation. Do you have that space back? And is there already a replacement tenant for that asset?

[Sumit Roy, executive]

We don't, Alex, which is why we are in litigation and which is where the upside comes from. So we've essentially said this year is going to be a resolution year. Once we get those assets back, we are very confident in our ability to find alternative clients in the C-store space for those particular locations. So that's where the upside is. And no, we are not expecting to resolve any of that this year.

[Alec Feygin, analyst]

Got it. That's helpful. And then maybe for Jonathan. What are you thinking about future debt issuances, what currency is currently most attractive? And at what rate can you issue at?

[Jonathan Pong, executive]

Yes, look, so if we were to sit here today and guess what indicative is might be on 10-year unsecured paper, you're probably looking at the very low 5s, call it, 5.1, 5.2 for U.S. dollar and sterling and then you're probably looking at very low 4s, about 100 basis points tighter in the Eurozone. So we always want to have a level of flexibility, I think when you look at how far wide sterling has traded relative to the dollar over the last few years and now that it's back to parity, we have been leaning more towards the dollar side over the last few years, and the optionality is there for us because we do have the currency net investment hedge capacity to be active in the sterling market.

But obviously, the more euro deals that we do and transact on the greater the ability for us to access 4% paper will be. So these are the kind of things that we think about on a daily basis. A lot of it depends on the currency of the assets that we're bringing on the books. But we're glad that we left quite a bit of capacity in these currencies that are starting to trade at parity or even inside of it relative to a dollar.

[Operator]

The next question comes from Spenser Allaway from Green Street Advisors.

[Spenser Allaway, analyst]

Maybe just one going back to the transaction market. Can you just comment on where you're seeing the largest bid-ask spreads either across property types or industries?

[Sumit Roy, executive]

For the first half of the year, Spenser, it was here in the U.S. That's the reason why our volumes were much lower than what was -- that's what was traditionally seen in what we've done. I think that's starting to compress that bid-ask spread, which is the reason why we feel pretty confident that the markets here in the U.S. is going to start to materialize favorably for us. And yes, so that's what we're seeing.

[Operator]

The next question comes from Ronald Kamdem from Morgan Stanley.

[Ronald Kamdem, analyst]

Just 2 quick ones for me. Just one, just on the interest cost. Can you remind us how much of the guidance this year, the FFO growth, how much of it was a drag just from higher interest expense and so forth? And how are you thinking about sort of the maturities in '25?

[Jonathan Pong, executive]

Yes. So definitely it wasn't much of a drag this year. I mean luckily, for us, we came out and did a debt offering in January and that was in the very low 5s, just above 5. So when you look at it on a year-over-year basis, not a big difference. We did obviously have a $350 million bond that we did repay. So there's a little bit of dilution from that. But I think when you look into 2025, we've got $1.8 billion, $1.9 billion, a 4.2% I just talked about how maybe there's 100 basis points of dilution if we were to do something like sterling and dollars based off of today's indicative rates that would have no more than about a 50 basis point impact to earnings.

So it's obviously come in quite a bit. But obviously, if we have something from a euro standpoint that we can take advantage of that it will be breakeven for 2025 for short-term borrowings. Yes, it has been a little bit more dilutive because we peaked with the Fed funds rate this year. But I think much better than it was last year where that was close to 2% of growth that was held back solely because of that.

[Ronald Kamdem, analyst]

Great. And then my second question was just on the new growth verticals specifically, just double clicking on sort of data centers and sort of gaming. Obviously, you've done 2 great deals with 2 great partners. But just wondering as you're thinking about sort of the future deals opportunity, is there sort of any lessons learned, any way that you want to structure it differently maybe that you're thinking about as the opportunity gotten more attractive, less attractive? Just trying to get a sense of where we are 12, 24 months into this process?

[Sumit Roy, executive]

Thanks, Ronald. So on the gaming side, just based on performance of the assets that we have visibility into -- it's clearly been a great investment for us. Both the assets that we currently either own 100% or partially owned have continued to perform, and we -- then the leases that were structured were, in our view, very favorable leases. It was a fair lease both to the operator and to us. And I'm not sure if there's anything there that we would change based on what we've learned over the last 2 years.

On the data center side, we've only got one investment that has now come online. And we are very excited about continuing to work with our partner, our existing partner and some new partners that we are trying to cultivate within this space. Like I've said, the hyperscale business with enterprise clients, it's a massive business and one that I don't think any single or even 3, 4 sources of capital can solve. And we believe that this is a total addressable market that has a place for somebody like us partnering with the right developers, operators to create our own portfolio that grows from where we are today.

And I don't need to go into the thesis as to the why, but it's fairly new for us to really reflect on lessons learned. We are still trying to build that particular pipeline up. And in time, I'm sure we will share lessons learned. But one of the things that we are very focused on, and this is not necessarily based on our own history, but the history of this particular sector is to make sure that the rents that we are underwriting to day one are rents that can be supported come to renewal time, even 10, 15 years out. And I think that was one of the lessons that this particular sector had to learn the hard way when they went through renewals and they were taking write-downs in the space.

But outside of that, make sure that things that can become obsolete are investments that we would want the operator to make. And we stay as close and as true to the real estate as we possibly can. That's really the lens through which we are looking at the data center space.

[Operator]

We have a follow-up question from Linda Tsai from Jefferies.

[Linda Yu Tsai, analyst]

Just on the 84% recapture rate. How much does that number move around any given year? And could that actually go down next year if you have a longer run rate for knowing when those closures are going to happen?

[Sumit Roy, executive]

No. The 84% is our historical average through the bankruptcy process. So any client that goes through a Chapter 11 process and if you compare the emerging rent to the pre-bankruptcy rent, that recapture rate is 84%. And Linda, if you look at the amplitude within that 84%, if you actually look at individuals, we've had situations where we've collected 70% or 65% of the rent. And then there have been situations where we've collected 100% of the rent pre-bankruptcy versus post bankruptcy. So there is variance around this 84%, but that has historically been what we've achieved. And that's the number that we are sharing with the market.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Sumit Roy for closing remarks.

[Sumit Roy, executive]

Thank you all for joining us today. We look forward to speaking soon and seeing you at conferences in the coming months. Bye-bye.

[Operator]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.