Realty Income Corp

NYSE:O

Earnings Call Transcript 2022-Q4

[Operator]

Good day, and welcome to the Realty Income Fourth quarter 2022 Operating Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Julie Hasselwander, Senior Manager of Investor Relations at Realty Income. Please go ahead.

[Julie Hasselwander, Senior Manager of Investor Relations]

Thank you all for joining us today for Realty Income's fourth quarter operating results conference call. Discussing our results will be Sumit Roy, President and Chief Executive Officer; Christie Kelly, Executive Vice President, Chief Financial Officer and Treasurer; and Jonathan Pong, Senior Vice President, Head of Corporate Finance.

During this conference call, we will make certain statements that may be 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-K. [Operator Instructions]

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

[Sumit Roy, President & Chief Executive Officer]

Thank you, Julie. Welcome, everyone. 2022 was a year of significant growth for our company. I would like to express my gratitude and appreciation to the Realty Income team, who have worked tirelessly to execute on our strategic objectives and all of our investors for their support. The result of our team's collective efforts was reflected in our 2022 results, highlighted by AFFO per share growth of 9.2%, the highest annual growth rate for our company since 2013.

Additionally, we closed on approximately $9 billion of high-quality investments in 2022, including $3.9 billion in the fourth quarter, both the annual and fourth quarter investment volume set record highs for the company. Underpinning investment activity, transaction flow remains robust. We sourced $17 billion in the fourth quarter, bringing 2022 sourcing volume to $95 billion. Finally, we ended the year with occupancy of 99%, our highest occupancy rate at the end of a reporting period in over 20 years.

At Realty Income, we strive to provide stability and sustainable growth on behalf of our investors. And during periods of economic uncertainty like we find ourselves in today, the resilience demonstrated by our business model is important to highlight. During our 28-year history as a public company, our combined total return consisting of AFFO per share growth and dividend payments generated by our operations has not experienced a single year of downside volatility in the form of negative total returns.

We believe we are in a very limited company among companies in the S&P 500 who can make that claim. This is a testament to the durability of our underlying cash flows, which is supported by a diversified portfolio of properties under long-term leases with clients that are leaders in their respective industries. We are constantly working to incubate new swim lanes for growth that offer attractive risk-adjusted returns.

Since the start of 2022, we have expanded our

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to new verticals to our platform. In October, we completed our debut transaction in Italy, acquiring seven wholesale clubs operated by Metro AG, an investment-grade pan-European leader in the wholesale club industry. As we discussed in 2019, when we purchased our first property internationally, we are intentional about consolidating the fragmented commercial real estate market in Europe and Italy represents the third country abroad in which we now have a presence.

In December, we closed our $1.7 billion acquisition of Encore, Boston, Harbor, Resort and Casino from wind resorts, which represent our first transaction in the gaming industry. The property is a good example of our strategy to partner with best-in-class operators to acquire high-quality real estate. It was purchased at a discount to estimated replacement cost is subject to a long triple net lease of 30 years with attractive annual rent escalators and is located on prime real estate with structural barriers to competition.

As anticipated in August 2022, Massachusetts partially legalized professional and collegiate sports wagering for the state, unlocking an estimated $850 million of gross annual gaming revenue and further supporting the strategic importance of this asset.

In addition, we are pleased to announce a significant investment in what we are calling the consumer [technical difficulty] through the acquisition of a 224-property portfolio of dental practices during the fourth quarter. We expect this $520 million transaction to be just the start of additional investments we hope to make in a sector that we estimate has a total addressable market in the U.S. of nearly $1.8 trillion in real estate.

We believe the consumer-centric medical industry shares many of the same attributes of the nondiscretionary service-based uses that make up much of our portfolio, and that have proven resilient throughout our company's long history. These locations offer essential goods and services in and around the major thoroughfares in which our assets are

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for properties leased appliance in the consumer-centric medical industry is extremely fragmented, which creates consolidation opportunities, we believe we are well suited to address.

We believe this industry will continue to move towards a patient-centric model. The trend towards the ovation model has been ongoing for decades, but we expect this shift to occur in an accelerated fashion post pandemic and will manifest in several ways that support our investment in the industry.

First, the convenience of having care delivered closer to the patient will increase accessibility to the patient and reduce costs for all, including patients, payers and providers; second, existing clients of ours like Walgreens and CVS will continue to disrupt the status quo as they gain an increasing share of primary care over time. And third, we believe these industry dynamics will help lower the per capita spend on health care in the U.S. and help improve the quality of outcomes.

It is also important to note that the adjacency and fungibility of these assets are a strong fit with our existing footprint from a real estate standpoint. As we underwrote this industry, we conducted a study analyzing over 30,000 variables and found that our portfolio had a 90% similarity with a data set of assets in this industry.

and we look forward to increasing our exposure over time. Moving on. As we announced earlier this week, actually yesterday, we have entered into a strategic alliance with Plenty, an emerging leader in vertical farms operations to support the development of Plenty's indoor vertical farms.

As the initial transaction of the alliance, we will fund the development of an indoor vertical farm asset near Richmond, Virginia, located adjacent to an Amazon distribution facility. Plenty's highly automated farming architecture efficiently harnesses scarce natural resources to generate production yields that it believes are up to 350 times greater per acre than conventional farming.

We regard Plenty at the forefront of a structural evolution in crop production and

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growth plans. In summary, these distinct new verticals are representative of the growth opportunities we expect to unlock over time to create value for our shareholders.

Moving on to our portfolio. In addition to our record occupancy at year-end, we are proud to have delivered a rent recapture rate of 103.8% during the fourth quarter on properties renewed or re-leased, bringing our full year recapture rate to 105.9%.

We attribute these results to our proactive asset management efforts, the underlying quality of our real estate and our rent levels in the portfolio relative to market. Despite our recent accomplishments, we are still working through the impact of the pending bankruptcy on our Cineworld exposure, which is 1.4% of our total portfolio annualized base rent. As a reminder, -- we own 41 assets, 17 of which are subject to a single master lease agreement and 22 of which have been accounted for under cash basis accounting since the third quarter of 2020.

Following the announcement of the Cineworld bankruptcy in September 2022, we have collected 100% of contractual rent in each month from October 2022 through February 2023. As resolution on the bankruptcy has not yet materialized, we deemed it appropriate to revisit as we've had on our Cineworld receivables balance as we continue to evaluate the collectability of these amounts.

As a result of this analysis and an abundance of caution, in the fourth quarter, we recorded $13.7 million of additional reserves associated with nine Cineworld properties previously on accrual accounting.

In total, we now have $35.6 million of cumulative reserves on 31 properties that are on cash basis accounting, representing approximately 70% of our outstanding receivables from Cineworld. As a result of these changes, our unreserved receivable outstanding from Cineworld was $15.6 million at year-end, excluding straight-line rent receivables and including both deferred contractual rent and deferred expense recoveries.

The 31 properties on cash basis accounting currently account for approximately $2.6 million of monthly contractual base rent. Based on public information and our proprietary analysis, we continue to believe our portfolio of Cineworld assets generally comprised of the stronger performance in the operator's portfolio, and we will provide an update on the outcome of our negotiations when appropriate.

Finally, in January, we were pleased to welcome Greg White as Chief Operating Officer. The COO role has been vacant since 2018 when I assumed the role of CEO. And having known Greg for many years, I believe he has the experience, leadership qualities and business acumen to add immediate value to the management team.

Most recently, Greg served as a senior adviser in the Real Estate and Lodging Investment Banking group at UBS Securities. I admire Greg's extensive knowledge of the commercial estate space and his thoughtfulness and integrity will mesh well with our culture at Realty Income.

I will now pass the call over to Christie, who will further discuss results from the quarter.

[Christie Kelly]

Thank you, Sumit. Moving on to the balance sheet. As publicly disclosed, we've been quite active on the capital markets front. During the fourth quarter, we raised approximately $52 billion of equity proceeds primarily through our ATM program and when including equity sold in the first quarter of 2023, and we currently have approximately $850 million of unsettled forward equity available for future issuance.

Throughout 2022, a we raised over $4.6 billion of gross equity proceeds at a weighted average price of $67.04, almost entirely through our ATM program. We ended the year with net debt to annualized adjusted EBITDA in our targeted range at 5.5 time or 5.3 time giving effect to the annualization. Please note that these ratios do not reflect the outstanding equity forwards I referenced previously.

Our capital market activities in the fourth quarter and in January were aimed at striking the right balance between terming out our short-term borrowings while providing us the flexibility to participate and a lower rate environment over the next three years. In addition to the 10-year $750 million senior unsecured bond issuance we priced in October at an effective yield of 3.93%.

In January, we executed a dual tranche $1.1 billion senior unsecured bond offering. The offering consisted of $500 million three year notes callable after one year and $600 million of seven-year notes. In conjunction with the three-year note, we capitalized on an attractive window to swap our interest payments from a fixed to variable rate structure, which we expect will replace a portion of our existing variable rate exposure in the capital stack.

After giving effect to the interest rate swap, we effectively locked in a variable rate spread of negative 3.5 basis points to SOFR, which represents estimated savings compared to our credit facility of over 85 basis points. It is important to note that the $500 million of variable rate exposure is expected to be in lieu of variable rate borrowings we would otherwise have outstanding on our revolver or on our commercial paper program.

Lastly, in January, we closed on a new $1 billion multicurrency unsecured term loan with an initial tenor of one year and with two 12-month extension options. In conjunction with closing of the term loan, we entered into a variable to fixed-rate swap resulting in an all-in effective yield of 5%.

I would like to take a moment to say thank you to each of our lenders that participated.

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I would also like to make special mention of Jonathan Pong and Steve Backe for their tireless efforts and leadership in delivering upon our capital market strategies.

Moving on to guidance for 2023. We are initiating AFFO per share guidance of $3.93 to $4.03, representing 1.5% growth at the midpoint of the earnings range and including our current dividend yield, a total operating return profile of circa 6%.

So, the annualization of higher interest rates has moderated our expected growth rate for 2023, there is much to be optimistic about. The investment pipeline remains active. We continue to source investment opportunities across our target markets at accretive cap rates in the mid-6 to mid-7 range.

As a result, we are introducing 2023 investment guidance of greater than $5 billion, and we will, of course, revisit this guidance each quarter as we gain incremental visibility to our transaction pipeline. Finally, as the monthly dividend company, an increasing monthly dividend remains central to our business model. We were pleased to have announced a dividend increase of 2.4% last week which represents a 3.2% growth rate over the year ago period. We remain proud to be one of only three REITs in the S&P 500 Dividend Aristocrats Index for having a dividend every year for over 25 consecutive years.

With that, I would like to pass the call back to Sumit.

[Sumit Roy, President & Chief Executive Officer]

Thank you, Christie. In summary, our 2022 results demonstrated the capabilities of our platform and the competitive advantages afforded to us given our size, scale and access to capital. Over the long term, we believe stockholders will continue to benefit from the stability of our cash flows as we have proven with our track record of consistently positive total returns.

Finally, we believe there is significant runway for further growth in untapped industries, geographies

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We look forward to unlocking these opportunities over time. At this time, we can open it up for questions. Operator?

[Operator]

[Operator Instructions]. The first question comes from Josh Dennerlein with Bank of America. Please go ahead.

[Joshua Dennerlein, BofA Securities]

I wanted to ask about the Plenty indoor farm deal. I guess this is a new industry for you guys as well as it seems like a relatively new industry in general. I guess how did you guys get comfortable with underwriting the risk and outlook for indoor farming?

[Sumit Roy, President & Chief Executive Officer]

So, thanks for the question, Josh. Into farming, as part of the revolution that we are seeing in ag tech is something that we've been looking at for the better part of a year now. And specifically working with plenty to try to understand their technology and how they're going to play in the ecosystem in terms of delivering crops in a much, much more efficient manner than traditional farming. If you look at ag tech and you look at vertical farming within this space, this is estimated to be a $50 billion industry over the next few years.

And Plenty has a very established position within this particular vertical. If you look at some of the sponsorship that they have, it's with companies like Walgreens, Albertsons, and [indiscernible]. These are some of the largest grocers and providers of end product to grocery stores.

And Walmart has also invested directly in this company, along with [technical difficulty] from which they're going to be served the end product. So, they have a lot of institutional sponsorship. We've gotten to know the company very well. And at the end of the day, it's a $42 million investment, very well-located industrial location happens to be very adjacent to an Amazon box.

And we felt very comfortable based on the risk-adjusted return profile across various different scenarios that this was going to be a solid real estate investment.

Having said all of that, one of the phrase that was used internally, the cherry on the top was the fact that this aligns with our value system as well, the value of giving more than we take. We genuinely believe that ag tech and vertical farming, specifically is going to have a big role to play in a world that continues to be resource constrained, yield constrained, water constrained and continued deficiency of arable land going forward.

So, for all of those reasons, we got very comfortable with Plenty as an operator, and more importantly, this particular vertical within ag tech as an industry to pursue.

[Joshua Dennerlein, BofA Securities]

And then could you maybe elaborate a little bit on like the returns and the outlays, I know it's a $1 billion pipeline. Like is that something you expect to kind of put out the door all this year over the next 2, 3 -- and are you guys financing the equipment inside the warehouse? Just trying to get more color on the deal.

[Sumit Roy, President & Chief Executive Officer]

Sure. So, we are a real estate company, Josh, first and foremost. So that's all we are going to be investing in. Any equipment, all of the technology, et cetera, that is Plenty's responsibility. And so, none of the $42 million will go towards that. The $1 billion is a number that we hope to be able to invest with this name, which if we do would mean that this technology has become a success, and more importantly, this its

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position as one of the leaders vertical farming.

The investment itself has a much longer horizon, I would say, potentially the next five years. But keep in mind that any subsequent investment beyond the $42 million is on -- is at our option. And so obviously, we are going to approach this partnership from a purely real estate perspective.

But a perspective that we do believe needs to partner with these types of technologies in order for these technologies to be successful. But ultimately, the real estate needs to work for us on a risk-adjusted return basis. And if that does, we are happy to help a company like Plenty is continue to establish itself as a front runner in this space.

[Operator]

Our next question comes from Anthony Paolone with JPMorgan. Please go ahead.

[Anthony Paolone, JPMorgan]

Great. Thank you. Sumit, can you expand a bit on the consumer medical vertical that you talked about in terms of what are the types of service offerings that are most interesting to you right now? What do those boxes look like types of operators, so forth, yields, maybe?

[Sumit Roy, President & Chief Executive Officer]

Yes. So, when we're talking about consumer-centric medical, we're talking about stuff that we are already currently exposed to and adding a few more areas around the edges. So, what are those areas? Like we are already exposed to drug stores, but drugstores of yesterday is not the drug store of tomorrow.

What you've probably heard in the press both Walgreens and CVS are investing very heavily to continue to take share of the physician -- the general physician services. And this is an incredibly fragmented area of the business, and they are investing multibillion dollars in their health hub, minute clinics, et cetera, to -- be able to provide those services.

And so that will continue to be an area, infusion centers, dialysis, eye care, dental care, pediatric care, behavioral facilities, urgent care, those are all concepts that have gained tremendous momentum, especially post pandemic, and we'll continue to gain momentum as a method of delivering health care to the end consumer.

And the belief here is that the per capita health care cost that we in this country experience is essentially 2 time the average of what an OECD company -- country experiences. And how do we continue to bring that down? And factors like convenience, being closer to the consumer, making sure that there is a relationship that can be established. So, issues can be addressed on the front end rather than when it becomes an issue later on in life.

I mean, today, if you look at the U.S. health care, only 30% of the population actually has a general physician that they can identify as their own. 70% don't have one, and this goes back to preventative care as being a precursor to reducing the cost of health care. And that is the business model that we have embraced that we believe will be -- in addition to the traditional ways of delivering health care will be a very important step in helping reduce cost.

And so, anything that sort of lends any concept that lends itself to this will be open season for us. And what we have then looked at it is to try to analyze the actual boxes that these types of facilities are housed in. And what we found was that there is a 90% -- and I mentioned this in my prepared remarks, there's a 90% overlap with locations and boxes that we have in terms of size, in terms of et cetera.

And there are a whole slew of variables that we looked at. And these assets that lend themselves to consumer-centric medical. And so, there are a lot of synergies. It is incredibly fragmented. It's a $1.8 trillion market today, expected to grow to $2 trillion by 2027. And it's all about increasing our total addressable market, using our core strength that we bring to the table to help consolidate the market and continue to sort of redefine what net lease investing is. And this is a perfect example

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you had -- if you were saying something post the end of my answer, we missed all of that. So, you're back on.

[Anthony Paolone, JPMorgan]

Okay. Sorry about that. And then my second question relates to yields and thinking about just near term, like the first and second quarter, I think you mentioned mid-6s to mid-7s. You did 6.1 in the fourth quarter, but just -- does it -- should we expect that it moves into that range here in the near term? Or is that a number that you might get to over the course of the year? Just trying to think through what you're seeing on the ground today?

[Sumit Roy, President & Chief Executive Officer]

Yes, Tony. We actually put out some numbers on January 9, we put out, I think, a pro sup when we were offering the unsecured bonds, where we shared the pipeline with you, and then the pipeline included transactions under contract and accepted LOIs.

And that was circa $1.3 billion worth of transactions, a 7.1% cash cap rate. So clearly, what we are talking about in terms of finally the cap rates moving is now manifesting itself in the pipeline that we have created or we had created until that point.

And now more stepping back and more generally speaking, we have seen about 100 basis points plus/minus movement in cap rates, which we expected given that if you look at even 14 of the top 20 clients that we have, who have bonds that are trading, you look at what their spreads have done over the last, call it, eight months, nine months, those have gapped out about 100 basis points.

So not that, that symmetry is perfectly congruous, but it seems to have been at least in terms of how cap rates have played out. So, you should be expecting to see those numbers being realized starting in the first quarter of 2023.

[Anthony Paolone, JPMorgan]

Okay. Thank you.

[Operator]

Our next question comes from Greg McGinniss with Scotiabank. Please go ahead.

[Greg McGinniss, Scotiabank]

Good afternoon. Sumit, regarding M&A, is that more or less likely in this environment with these opportunities you're finding in other verticals and portfolio discounts like we saw in CIM 71 cap? Or I mean, this paying a premium for public peer makes sense at this time?

[Sumit Roy, President & Chief Executive Officer]

Greg, that's a great question. Look, -- the -- if you look at the organic market and you've mentioned CIM and some of the other transactions that we've talked about already, there are very good transactions to be had at incredibly good risk-adjusted returns. Having said that, if there's an opportunity on the M&A front where you're able to realize similar economics, I don't see that as being mutually exclusive to be able to pursue both avenues of ultimately what we are charter to do, which is grow the business.

But it does have that backdrop to compete against as an opportunity cost when we are looking at M&A. But I don't see there being less M&A because of the environment we find ourselves in. It's just the question of are we going to have partners who are willing to see the big picture, we're willing to see that being part of a particular pro forma company is better for the outlook than not.

I think those are the elements that need to sort of play out on the sellers' behalf, in order to perpetuate M&A transactions. But look, we are very happy going down the path that we have -- that we are going down. We did $9 billion of acquisitions last year. I would say that, that's probably -- if you look at companies in our sector that takes care of 80%, 90% of what companies are in terms of their total size. So, we don't have to do M&A in order to continue to grow our business. self, and it makes sense for us to pursue that. We are not going to shy away from that either.

[Greg McGinniss, Scotiabank]

Okay. That's reasonable. And just for a second question here. Have the higher cap rates started to bring some of the private and private equity buyers off the sidelines? Or is competition for assets still limited?

[Sumit Roy, President & Chief Executive Officer]

They're certainly out there. The debt capital markets continues to be a constraint for them and their ability to react quickly in this market. I think certainty of close over the last six months has taken on a very different focus for potential buyers who, for a variety of reasons won't monetize their real estate.

And somebody like us, especially when it comes to bigger deals that can have that certainty of close that does not rely on the debt capital markets to finance their deals. I think has a distinct advantage which truth be told has played out in our favor over the last few months. And so yes, private equity will obviously start to sniff around given the higher cap rate environment. But I still don't think that their cost of capital is as competitive as ours and our ability to close still, I believe, stands out when potential sellers have to evaluate who to partner with.

[Greg McGinniss, Scotiabank]

Great. Thank you.

[Operator]

Our next question comes from Spenser Allaway with Green Street Advisors. Please go ahead.

[Spenser Allaway, Green Street Advisors]

Thank you. As it relates to cap rates, we've heard that the bid spread has compressed faster in the U.S. versus Europe. Is that consistent with what you've seen? And do you think that will dictate how you deploy capital in '23 as you look across both geographies?

[Sumit Roy, President & Chief Executive Officer]

Yes, that's a great question, Spenser. It doesn't have a perfect answer. If you look at the fourth quarter, we didn't do a lot of volume in Europe, circa $350 million, but they had a substantially higher cap rate. And the dynamic that played out there was essentially redemption issues that a lot of funds started to face towards the end of the year.

And that sort of precipitated monetizing their real estate portfolios to help meet those redemption issues, which obviously created an opportunity for somebody like us who, again, does not rely on the debt capital markets, is able to do transactions fairly quickly.

And that's what resulted in that much higher cap rate. Because for the longest time in Europe, things were not moving. And that's the reason why the volume was only $387.9 [indiscernible], essentially happened towards the later part of the year, happened very quickly because of the specific dynamics.

In the U.S., the trend has been slowly moving in this direction. And again, I think I mentioned this during our third quarter call, much faster than it had traditionally moved when you have a rising interest rate environment. And that's just because so much of the capital was pulled out of the market that it pushed specially sellers who are inclined to monetize their real estate, continuing going down that path has allowed for the cap rates to move.

Having said all of that, I do believe that where we find ourselves today is more of a bottoming out of that continued movement of expanding cap rates.

And it's settling in the 6.5%, 7% for some of the products. Of course, there are still products that's trading in the high-5s. There's still some one-off assets that's trading in the low-5s, maybe even in the high-4s. We, in fact, sold one of our QSR assets with a 4% in front of it in terms of cap rates. So those markets, we will ignore because those are the tail areas of the cap rate environment. But by and large, we have seen this movement in cap rates play out and it's now starting to mentioned.

[Spenser Allaway, Green Street Advisors]

Okay. That was extremely helpful. Thank you. And there have been headlines regarding a EUR600 million to EUR700 million portfolio being marketed for which has been cited as a bidder. Is there anything you can share on the portfolio in terms of the general makeup or geography of those properties?

[Sumit Roy, President & Chief Executive Officer]

Yes. I wonder what your sources are, Spencer. We really don't want to talk about transactions that we don't have under contract. So -- we may or may not be involved in the transaction that you've mentioned. We can't speak to anything, which is a hypothesis or just a rumor in the industry. Sorry about that.

[Operator]

Our next questioner is Haendel St. Juste with Mizuho. Please go ahead.

[Haendel St. Juste, Mizuho]

Sumit, good afternoon. Just curious on an updated perspective on your high-grade philosophy here. I noticed again in the fourth quarter. The share was below your portfolio average even when you back out the Encore. In the past, I know you mentioned -- you have experience in acquiring higher-yielding assets and you're focused on the best risk-adjusted returns. But yet again, it's another quarter, your share of high-grade is far below the portfolio average. So maybe can you kind of give us some updated thinking on how we should think about that dynamic maybe going forward? Thanks.

[Sumit Roy, President & Chief Executive Officer]

I think you've sort of answered the question that you asked, Haendel. Ultimately, this is a game of finding the best risk-adjusted returns, just like you said, and the fact that something tends to be investment grade is an output of that underwriting. It's not something that we seek out. And the counter to what you're seeing in the fourth quarter is a CIM transaction, for instance. Here, we have an $894 million transaction with 48% of the rent coming from investment grade. And we were able to get a healthy cap rate.

So that number is going to continue to move. In fact, if you were to just look at the $3.9 billion we did in the fourth quarter and like you did exclude the wind transaction, and one of -- a couple of the larger portfolio transactions that we did, that particular investment-grade number would be right up in the high 40s. So, that's going to fluctuate quarter-by-quarter. And what we need to get comfortable with is based on the risk that we are assuming and part of which is the credit risk are we being appropriately compensated. And if the answer comes back, yes, based on expected outcomes, then we are very comfortable continuing to pursue those transactions.

[Haendel St. Juste, Mizuho]

That's helpful. I wanted to ask about Italy for a moment. Was the investing in the quarter basically the $350 million in Europe that you mentioned in of your earlier remarks? And then maybe can you talk a bit about the relative risk profile, how you're underwriting there versus perhaps the rest of the Europe or the United States? And what's the, I guess, investment appetite for Italy?

[Sumit Roy, President & Chief Executive Officer]

Look, Italy, as a country, definitely has more risk. But again, -- just like when we invested in the grocery business during the midst of Brexit, and we were very particular about the industry and more importantly, the operator within that industry that we were partnering with. If you look at Metro AG, it's an investment grade, very profitable, very well-established business, which is pan-European, I believe it's headquartered in Germany, and it controls 26% of the wholesale business in Italy.

They have been established since the early 1970s in some of our locations. And so this is a business that we feel very comfortable with. Think of Metro as a combination of Costco and Cisco. Costco is very much retail-oriented and Cisco is much more professionally oriented. Both those businesses types of businesses is served out of Metro, and that's not going anywhere despite some of the additional country-specific risk that might exist in Italy. There are structural advantages as well that I'm not going to bore you with, which makes Italy a very interesting place to invest.

But we are going to be very particular, just like we were in the U.K. and we were in Spain as to who we partner with, what are the concepts that we are going to be exposing ourselves to. And at the end of the day, what is the risk-adjusted return profile, look, taking into account some of these risks in some cases, additional risk that won't takes going into these new countries. But we feel very good about the investment that we've made with Metro in Italy.

[Haendel St. Juste, Mizuho]

And just if I may, the follow-up is, did you -- is it $350 million in the quarter and ballpark, what are the going in cap rates or set of returns?

[Sumit Roy, President & Chief Executive Officer]

No, it wasn't all of $350 million. $350 million was the total investment that we made in Europe. I believe the Metro was €165 million or €165 million was the Metro investment. Most of the other investments were in the U.K.

[Haendel St. Juste, Mizuho]

Cap rate?

[Sumit Roy, President & Chief Executive Officer]

You've got the blended cap rate, I believe, in the supplemental. It was 100 basis points north of what we did in the U.S., 7.1% cap rate. Sure.

[Operator]

Our next question comes from Ronald Kamdem with Morgan Stanley. Please go ahead.

[Ronald Kamdem, Morgan Stanley]

Just can we just touch on tenant health really quickly. Obviously, occupancy is 99%. I see that the EBITDAR coverage is up slightly quarter-over-quarter. In the past, you sort of talked about sort of stress testing the tent and feeling pretty good. Just outside of the movie theaters, just where is your head at in terms of potential recession and tenant health.

[Sumit Roy, President & Chief Executive Officer]

That's a great question, Ron, especially entering into 2023 with so much uncertainty. Look, our biggest focus right now is on Cineworld and how that's going to -- what that resolution is going to look like. I do believe that whatever that outcome is, it's going to play out within the next few months. It's been in bankruptcy now for the better part of four months, and we have been in negotiations with them, and we'll leave it at that.

Outside of that, if you look at our overall -- and again, this is something we share in the supplemental our cash flow coverages, full wall cash flow coverages, those have continued to trend up, largely a function of some of our existing clients continuing to outperform. Companies like Albertsons, et cetera, have continued to generate EBITDA growth on a four-wall basis, and therefore, those coverages have continued to improve.

Some of the new transactions that we have entered into have very healthy four-wall coverage ratios. And this is, again, it very much ties in with the comment that I think it might have been handled was talking about why are we doing so many noninvestment-grade. If you look at it from a real estate perspective and you suddenly have coverages north of 4x, 5x in sound businesses, but they don't have an investment-grade rating given their size.

Those are businesses that we will pursue. And so that's the reason why our four-wall coverage ratio is now close to 2.9x and it was in the 2.5 or about a year ago. So the health continues to be fairly good. If you look at what is there on our watch list, it's about 4% of our rent is on the tenant watch list. And as you can imagine, a lot of it is driven by the theater business. A lot of the theater assets are on our watch list.

And in some cases, we also have assets that may not have a credit issue, but there is a location risk associated with what will happen at the end of the lease term, given the changing demographics, changing competitive landscape, et cetera, et cetera. So that constitutes our 4%, which is slightly higher than what it was a few quarters ago. And it's largely a function of what's happening in the theater space and what we expect will happen in a continued high interest rate environment.

[Ronald Kamdem, Morgan Stanley]

Great. And then my second question, just touching on gaming. Obviously, the Encore deal closed. How is that going out as you have the assets and more importantly, what's the pipeline look like? How are you guys thinking about more -- doing more acquisitions in the gaming space.

[Sumit Roy, President & Chief Executive Officer]

Yes. So, we are very proud to own this beautiful asset in Boston. We just had a demonstration internally about our presence on LinkedIn and Twitter. And when we posted the news release around closing on this asset, we had a huge jump in following. So clearly, it was appreciated by the audience following Realty Income, and we are very proud to have this partnership with win. They are great operators. They are very good to sort of continue to understand and learn about this particular industry, and we hope to grow this industry.

We didn't do this as a one-off opportunistic transaction. And -- it's very much in line with looking for the best operators and trying to get assets that are going to be icons for the given operator, but even outside of that. And I think we have checked all of those boxes on the Boston asset. But finding those types of assets will continue to be we are focused on.

And as you can imagine, we have received several inbounds. But for a variety of reasons, we haven't chosen to pursue them because they don't need all of the attributes that we are looking for. So, we will be selective in this industry, but we would absolutely love to grow it over time.

[Operator]

Our next question comes from Wes Golladay with Baird. Please go ahead.

[Wes Golladay, Baird]

There's been a lot of M&A activity in the value-based care. So I was wondering if this is the industry you're referring to, where you see all the opportunity? And if so, would you get the parent's credit on some of these deals?

[Sumit Roy, President & Chief Executive Officer]

End up looking at Oak Street Health, for instance, that CVS ended up buying and they want to monetize some of those real estate then yes, by default, we are going to ask for CVS' credit on this $10 billion transaction that they just consummated. Walgreens has done a similar transaction. Amazon just announced that they did a similar transaction. Yes, it is precisely what we are talking about. We are calling it consumer-centric because we are approaching it from a pure state perspective and trying to find what are the alternatives of the locations that we have already -- and how does -- what are the synergies with this new vertical that we're pursuing.

It's certainly not looking at what traditional health care companies are focused on. That's not our forte. That's not our strength. And that has really no interest to us today. But it is the value-based health care that a lot of forward thinking health care companies, operators, health care operators are pursuing. And the derivative of that will be the real estate. It could be our existing pharmacies that are going to be repositioned to health hubs and minute clinics. That's already happening.

There's continued enhancement, there's continued higher impediments to switching costs that are getting created. Those are all perfect for us. That's embedded value that doesn't get realized day one, but we love to see that happen. And we also want to be intentional about growing the portfolio by doing the types of transactions that we did in the fourth quarter in this particular area because we do believe in it.

[Wes Golladay, Baird]

Got it. And then would you have, I guess, a lot of ground redevelopment opportunities? And then also, it sounds like you would have some redevelopment opportunities. Have you ever done redevelopment funding before? Or is that a big part of the business now?

[Sumit Roy, President & Chief Executive Officer]

We've certainly done redevelopment funding, Wes. If you look at our pipeline dollars today and some of that is repositioning of our existing assets. And we've done some in-house. We've done a lot of it with partners, national partners that we have. And those have been some of the best recapture rates that we have achieved in our portfolio.

So when we talk about this 90% overlap in terms of real estate characteristics, of the locations that we currently own and some of these consumer-centric medical concepts, that certainly lends itself to repositioning some of our assets for highest and best use. And we define highest and best use in terms of rent per square foot that we could recapture for a given location that we already own.

And so yes, I'd hope to be able to partner with these operators, show some of our existing vacancies, potential vacancies that are going to come down the pike. And reposition these locations to help provide these types of services. So yes, that is out of a value-enhancing proposition that we're going to explore.

[Operator]

Our next question comes from Michael Goldsmith with UBS. Please go ahead.

[Michael Goldsmith, UBS]

Can you talk about your view on interest rates in the capital markets based on your recent capital raising activities? It seems that Jonathan and Steve were busy with several less traditional items with the term loan with multiple extensions and the callable unsecured? Just trying to get a sense of what you're trying to achieve based on the laddering with these instruments.

[Jonathan Pong, Senior Vice President, Head of Corporate Finance]

Michael, it's Jonathan. I would say, the activities that we did in January, early January, it's all about financial flexibility. We, if you noticed, did a three-year non-call one, giving us that flexibility after one year to call at par. We also did a one-year term loan, but what two one-year extension option. And so, what we're trying to avoid, especially since we went long on the curve earlier in 2022 with our debt capital raising efforts, what was the lock in rates that these levels are very attractive to us.

We would like to think that over the next three years, there will be a more advantageous window for us to tap into the debt capital markets to term these amounts out. And so, it's really about maybe a little bit of a barbell given the activity we did earlier in the year, much lower long-term rates, but also terming out the revolver to an extent and creating that flexibility for us to participate and lower rates if they come.

[Michael Goldsmith, UBS]

And my second question, we've talked about each of the new verticals in depth, but just wanted to talk about the big picture associated with this. Does this -- is this a function of something has fundamentally changed with kind of the traditional core retail assets or industrial assets that you are known for. And I guess, does this -- these new opportunities provide more confidence in your ability to consistently hit or exceed the $5 billion of acquisitions that you've guided to the last couple of years?

[Sumit Roy, President & Chief Executive Officer]

That's a very good question, Michael. It's a question that we've asked ourselves. There is a traditional definition of what a net lease company does. And yes, we can certainly be mandated and dictated by that or there was a way for us to step back and say, look, if we look at Realty Income, what is our core strength today, our size and scale, which people have continued to point to as impediments to growth.

If you look at the last four years, we've grown our business at 5% CAGR annually. And if you look at the business, this question has been asked for the last 10 years was, we are going to take what has been used by The Street as an impediment and see if we can garner value for us shareholders, and let's just ask the question, what is it that we can do with the core strength of size, scale, cost of capital, that will be difficult for other companies to follow. And if the answer was, sorry, you're constrained by your business model and this is all you should do, and this is all you can do, that would have been the answer.

But what we found once we started last the question around redefining this particular space is that there's plenty for us to do. And we are only constrained by our ability to be creative. And ultimately, if we continue to underwrite these verticals and look at it from the perspective of real estate and look at it from the perspective of a net lease suddenly, the answers that start to pop up are very different. And it allows you to do things and allows you to be very creative and create outsized riches for our shareholders.

That with due respect, a lot of our peers are going to struggle trying to mimic. They just don't have the scale. And so, if we can help consolidate real estate, through a net lease structure, that is really the only governing principle that should be constraining us. And ultimately be able to show to the shareholders that on a risk-adjusted return, these are as safe, if not in some cases, safer than investing in traditional retail net lease businesses, then it's a win-win.

So that's how we are thinking about the business, Michael. And you will continue to see us be very creative. But like I've always done, and like this team here has always done, we will engage with you to share our thesis. And by the way, I do highly encourage everyone to go to the new deck, the investor deck, where we've laid out our thesis in more detail, and you'll see some numbers around -- and you'll find that this is what I think people invest in Realty Income for, and we are just delivering on that promise.

[Operator]

Our next question comes from John Massocca with Ladenburg Thalmann. Please go ahead.

[John Massocca, Ladenburg Thalmann]

So, we're reaching about the hour mark here, so I'll take us back to the beginning a little bit. As we think about the delta in the Plenty transaction between the $42 million committed for the Virginia projects, and the $1 billion headline opportunity? Do you have some kind of like right of first refusal or purchase option to kind of get to that higher number? Just trying to kind of figure out what's in the remaining amount beyond the $42 million for the actual project that's underway?

[Sumit Roy, President & Chief Executive Officer]

So John, the best way to answer that is any real estate development outside of a carve-out for one particular client that I mentioned already, which is a user of their end product, we basically get to take a look at the opportunity. And then if we wish not to pursue it, we don't have to. But we, as their real estate partner will be given an opportunity to look at any real estate development that they enter into over the next five or six years.

There's a time frame associated with that. But ultimately, the goal here is to continue to invest because that would mean that they are becoming a more and more successful operator within vertical farming, and we are their real estate partner going forward. But yes, so it is a concept of the optionality lies with us in terms of how much more we invest.

[John Massocca, Ladenburg Thalmann]

Okay. Understood. And then can you provide a little more color on the dental portfolio acquired in 4Q? What made that specific portfolio attractive? And can you provide some color on the credit behind of those assets?

[Sumit Roy, President & Chief Executive Officer]

So it's not rated. It was a situation where you had the operator own both the operations as well as the real estate. And this was a mechanism for them to monetize their real estate and continue to invest in the operations of the business. I think we are very constrained by what it is that we can share. This was a highly negotiated transaction but it is one that we are very excited about.

And this is, again, an advent into this consumer-centric medical real estate in a big way, and we felt like it was large enough for us to sort of engage in and talk about, but we can't be more specific than that. You know what our overall cap rate was for the quarter, and this was a very small component of it, given that it was a $4 million quarter. But that's the extent of what we can do about it.

[Operator]

Our next question comes from Linda Tsai with Jefferies. Please go ahead.

[Linda Tsai, Jefferies]

What are some of the benefits you hope to achieve by filling in the vacant role of the COO?

[Sumit Roy, President & Chief Executive Officer]

Greg is sitting right here, and he's already -- he's been with us about 1.5 months, and he's already added so much value to all of our discussions. It's very bright mind and now he's going to start blushing, but he's somebody that I've respected. I've known Greg for the last -- I guess now it's almost 15 years. And he has a perspective that he brings to the table that is very unique and is going to be incredibly additive to all of us. Look, our business is becoming more and more complicated. We are becoming a bigger and bigger organization. We need talented people to continue to that.

But the most important thing about Greg, in my mind is his integrity and his ability to -- and his leadership qualities and his ability to mentor -- those are all qualities that will be put to good use, especially with the next batch of leaders that we are cultivating internally and he will be a massive help in accelerating them to very senior leadership positions within the Company, which, by the way, this company will need in order to continue to execute its strategy and plan.

[Linda Tsai, Jefferies]

And then just in terms of recurring CapEx being less than 1% of Realty Income's NOI, does this vary whether the properties are domestic or international? And are your new verticals consistent with this threshold to?

[Sumit Roy, President & Chief Executive Officer]

It depends on the type of leases that we have. I will tell you that, for example, an industrial lease tends to have structural and roof responsibilities, that's on the landlord. And so obviously, CapEx there, not maintenance CapEx necessarily, but just CapEx in general -- is going to be higher. Now some of it will be viewed as maintenance. Some of it will be viewed as improving the life of the real estate. So the categorization of that CapEx may be different, but it is very much a function of the lease.

I would say that in the U.K., there is even on the retail side, there is not perfectly what we call quad net assets. So we do have a lot more leakage. But lot more leakage is a relative term to very little leakage here in the U.S. And so all said and done, it's not a big part of our business. It's something that we share. It's part of the AFFO. And again, all of that is underwritten when we are thinking about the long-term return profile of investments that we make, obviously take into consideration on the front end before moving forward on transactions.

[Operator]

Our next question comes from Tayo Okusanya with Credit Suisse. Please go ahead.

[Tayo Okusanya, Credit Suisse]

Just a quick follow-up on Haendel's question. So again, doing a little bit more in the non-IG space, your watch list is a little bit bigger. On the flip side, your rent coverages are getting stronger and stronger. How do we think about just kind of credit provisioning on a going-forward basis with all these kind of in factors and what you kind of look at as kind of adequate provisioning relative to historical levels, does kind of given the business backdrop.

[Sumit Roy, President & Chief Executive Officer]

Yes. Tayo, it's not a perfect science. You've put forth two data points that we've shared with you that are polar opposites. How in this backdrop of uncertainty we have four-wall coverages that continue to improve, yet we are doing less and less of investment grade, but that goes back to the underwriting. And I already mentioned to you that there are a couple of retail names that are not investment-grade but to have coverages north of 5x.

And again, it's a question of are these businesses that we are comfortable with. With the backdrop of this high interest rate environment, we are not going to be doing transactions where you're going to have an operator that doesn't have a business model that can sustain what we are going to experience, especially in the near term because that would not be good.

So, I don't think we should over-index to investment-grade. I know it makes the conversation so much easier with the outside world. But what we have to rely upon is where can we get return profile -- is superior to alternatives. And I think that's how we are thinking about our business. We clearly have provisioned because of this uncertainty, we clearly have provisioned in our guidance, a higher bad debt expense.

But last year was a phenomenal year for us. We had a similar provisioning that we kept adjusting throughout the year and ended up actually having bad debt expense below what we have traditionally experienced in the business. So again, we expect the worst we underwrite to what we expect and allow for the better outcomes to play out. And that's really how we think about our business, Tayo.

[Tayo Okusanya, Credit Suisse]

Okay. Could you share any specific numbers about the provisioning of like 60 basis points or 75 basis points is the bogie?

[Sumit Roy, President & Chief Executive Officer]

You mean in terms of what we have in the earnings guidance?

[Tayo Okusanya, Credit Suisse]

In the guidance, yes, in the guidance.

[Sumit Roy, President & Chief Executive Officer]

Yes, I don't think we're going to give that level of guidance because I guess what's going to happen, Tayo. Every year subsequent to this, people are going to want to know that. Just take a look at our history. You've got bad debt expense. It's an income statement line item. You can take a look at the history, and you can see that historically speaking, we've been in this 20 to -- code and last year was better than that. So you can now take that information, overlay what we expect to happen over the next 12 months, and that's how you should create your models.

[Operator]

Our next question comes from Josh Dennerlein with Bank of America. Please go ahead.

[Josh Dennerlein, Bank of America]

Just one more, just on the tenant front, I don't think we touched the watch list, saw some news on kind of -- or the Red Lobster has been in the news, I guess, they closed a few stores. Any kind of updates on the watch list and maybe just Red Lobster in general?

[Sumit Roy, President & Chief Executive Officer]

You missed it. Somebody else asked us about the watch list. It's right around 4%. You brought up Red Lobster, there were rumors around that Red Lobster was trying to negotiate rents with landlords, I can unequivocally tell you that, that is not the case, at least they haven't reached approached us. There certainly was assets that they have closed again, none of which impacted our portfolio.

And there are some challenges with that operation. It represents about 1% of our rent. But again, I do think that some of the missteps that they had made in the third, fourth quarter of last year have essentially been reversed. They were slow to make pricing adjustments. They have rectified that. And they are managing their inventory much better and all of those should result in better performance. But I just wanted to make sure that we were talking about facts and not rumors that have percolated in the rumor mill.

[Operator]

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

[Sumit Roy, President & Chief Executive Officer]

Well, thank you, Dave, for hosting us, and thank you, everyone, for joining in. I look forward to seeing you guys in the upcoming conferences. Take care.

[Operator]

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