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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to the Realty Income Third Quarter 2018 Operating Results Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Janeen Bedard. Please go ahead.
Thank you all for joining us today for Realty Income's third quarter 2018 operating results conference call. Discussing our results will be Sumit Roy, President and Chief Executive Officer; and Paul Meurer, Chief Financial Officer and Treasurer.
During this conference call, we will make certain statements that may be considered to be forward-looking statements under federal securities law. The Company's actual future results may differ significantly from the matters discussed in any forward-looking statements. We will disclose in greater detail the factors that may cause such differences in the Company's Form 10-Q.
We will be observing a two question limit during the Q&A portion of the call in order to give everyone the opportunity to participate.
I will now turn the call over to our President and CEO, Sumit Roy.
Thanks, Janeen. Welcome to our call today. I am honored to have taken on the role as CEO and I am excited about the future of Realty Income given the strength of our diversified high quality portfolio, strong investment opportunities, and most importantly our talented team.
I look forward to continuing to work closely with the Board and the team to evolve and execute on our strategic priorities, and I am confident Realty Income can continue to capture opportunities to build and enhance our portfolio and drive value for our stakeholders.
I would also like to thank our former CEO, John Case, for his service and guidance over the years. John has played a pivotal role in building the Company into what it is today and we wish him the very best. In my seven years with the Company, I've had the opportunity to meet many of our investors and analysts and I look forward to enhancing this engagement in the future. With that, let’s turn to the business.
We continue to see strength in the current market environment as well as our investment pipeline. During the third quarter, we invested $609 million in high quality property acquisitions and increased AFFO per share by 5.2%. S&P raised our credit rating to A- during the quarter, which was largely driven by our consistent track record of performance and the stability of our portfolio.
Given the current strength in our business, we are increasing the low-end of our 2018 AFFO per share guidance by $0.02, from $3.16 to $3.21, to a range of $3.18 to $3.21. Our portfolio continues to be diversified by tenant, industry, geography, and to a certain extent property type, which contributes to the stability of our cash flow.
At the end of the quarter, our properties were leased to 260 commercial tenants in 48 different industries located in 49 states and Puerto Rico. 81% of our rental revenue is from our traditional retail properties. The largest component outside of retail is industrial properties just over 12% of rental revenue.
Walgreens remains our largest tenant at 6.4% of rental revenue. Convenience stores remains our largest industry at 12.1% of rental revenue. Within our overall retail portfolio, over 90% of our rent comes from tenants with the service, non-discretionary and/or low price point component to their business.
We believe these characteristics allow our tenants to compete more effectively with ecommerce and operate in a variety of economic environments. These factors have been particularly relevant in today's retail climate with the vast majority of recent U.S. retail bankruptcies have been in industries that do not possess these characteristics.
We continue to have excellent credit quality in the portfolio with over half of our annualized rental revenue generated from investment grade-rated tenants. The weighted average rent coverage ratio for our retail properties is 2.9x on a four-wall basis, while the median is 2.7x. Our watch list at 1.4% of rent remains consistent with our levels of the last few years.
Occupancy based on the number of properties was 98.8%, an increase of 50 basis points versus the year-ago period. We expect occupancy to remain in the mid-98% for 2018. During the quarter, we released 64 properties, recapturing approximately 108% of the expiring rent.
Year-to-date, we have released 166 properties, recapturing approximately 106% of the expiring rent. Since our listing in 1994, we have released or sold over 2,800 properties with leases expiring, recapturing 100% of rent on those properties that were released.
Our same-store rental revenue increased 1% during the quarter and 0.9% year-to-date. These results are consistent with our projected run rate for 2018 of 1%. Approximately 87% of the releases have contractual rent increases.
Let me hand it over to Paul to provide additional detail on our financial results.
Thanks, Sumit. I will provide highlights for a few items in our financial results for the quarter, starting with the income statement. Our G&A as a percentage of total rental and other revenues was 5% for the quarter and 5.3% year-to-date.
We continue to have the lowest G&A ratio in the net lease REIT sector, excluding the recent CEO severance payment. We continue to project G&A to be approximately 5% in 2018. Our non-reimbursable property expenses as a percentage of total rental and other revenues was 1% for the quarter and 1.4% year-to-date. This compares favorably to our 2017 run rate due to lower bad debt expense and the timing of certain expenses.
We continue to expect non-reimbursable property expenses to generally be in the 1.5% to 2% range. Funds from operations or FFO per share was $0.81 for the quarter. As a reminder, a reported FFO follows the NAREIT-defined FFO definition. Adjusted funds from operations or AFFO or the actual cash we have available for distribution as dividends was $0.81 per share for the quarter, representing a 5.2% increase.
Briefly turning to the balance sheet, we've continued to maintain our conservative capital structure, which we believe contributed to the SMP upgrade to A- that Sumit mentioned earlier. Combined with our upgrade to A3 by Moody's a year-ago, we are now one of only a few REITs with at least AA ratings.
During the third quarter, we issued $293 million of common stock primarily through our ATM program. Our overall leverage remains modest as our debt-to-EBITDA ratio remains 5.5 times, and our fixed charge coverage remained healthy at 4.6 times. The weighted-average maturity of our bonds is approximately nine years, which is over a year longer than it was a year-ago.
Our overall debt maturity schedule remains in excellent shape with only $7.3 billion of debt coming due the remainder of this year and only $91 million coming into next year and our maturity schedule is very well laddered thereafter.
In summary, we continue to have low leverage, strong coverage metrics and excellent liquidity. Last week, we were very pleased to announce the expansion of our $3.25 billion unsecured credit facility. The new facility increases the capacity of our revolver from $2 billion to $3 billion, plus a $1 billion accordion expansion feature.
The initial maturity date is March 2023 plus 2 6-month extension options, thereafter. The increased line capacity enhances our liquidity and provide ready access to capital for our property acquisition efforts. Our borrowing spread decreased to 77.5 basis points over LIBOR, which matches the tightest pricing grid in the REIT industry.
As part of the recast, we also issued a new $250 million term loan with a tenor of just under 5.5 years. Concurrently, we executed a floating to fixed interest rate swap, which effectively fixed the interest rate on the term loan at 3.89%.
23 lenders participated in the new credit facility, many of whom we have done business with for several years. We very much appreciate the long-term support of our banking partners as we've grown over the years and we welcomed the lenders who are new to the relationship with Realty Income.
Now, let me turn the call back over to Sumit.
Thanks Paul. I’ll now move to our investment activity. During the third quarter of 2018, we invested $609 million in 238 properties located in 25 states, at an average initial cash cap rate of 6.34% and with a weighted-average lease term of 15.3 years.
On a revenue basis, approximately 62% of total acquisitions are from investment-grade tenants. 99.4% of the revenues are generated from retail. These assets are leased to 19 different tenants in 14 industries. Some of the most significant industries represented are convenience stores, restaurants, and dollar stores.
We closed 14 discrete transactions in the third quarter. Year-to-date 2018, we've invested $1.465 billion in 591 properties located in 37 states at an average initial cash cap rate of 6.32%, and with a weighted-average lease term of 14.4 years. On a revenue basis, 67% of total acquisitions are from investment-grade tenants.
96% of the revenues are generated from retail and 4% are from industrial. These assets are leased to 37 different tenants in 20 industries. Of the 39 independent transactions closed year-to-date, 5 transactions were above $50 million. Transaction flow continues to remain healthy.
During the third quarter, we sourced more than $8.4 billion in acquisition opportunities. Of the opportunities sourced during the third quarter, 58% were portfolios and 42% or approximately $3.6 billion were one-off assets. Year-to-date, we sourced approximately $26 billion in potential transaction opportunities.
Investment-grade opportunities represented 39% of the volume sourced for the third quarter. Of the $609 million in acquisitions closed in the third quarter, 7% were one-off transactions.
As to pricing, cap rates have essentially remained unchanged in the third quarter. Investment-grade properties continue to trade around 5% to high 6% cap rate range, and non-investment grade properties trade from high 5% to low 8% cap rate range.
Our investment spreads, relative to our weighted-average cost of capital were healthy, averaging 154 basis points in the third quarter, which was slightly above our historical average spreads. We define investment spreads as an initial cash yield less our nominal first year weighted-average cost of capital.
Our investment pipeline remains robust and we continue to see a steady flow of opportunities that meet our investment parameters. We remained one of the only publicly traded net lease companies that has the scale and cost of capital to pursue large corporate sale leaseback transactions on a negotiated basis.
Year-to-date, 81% of our acquisitions have been sale leaseback transactions. We remain confident in achieving our 2018 acquisition guidance of approximately $1.75 billion.
Our disposition program remained active. During the quarter, we sold 20 properties for net proceeds of $35.5 million at a net cash cap rate of 8.3% and realized an unlevered IRR of 7.8%. This brings us to 60 properties sold year-to-date for $83 million at a net cash cap rate of 7.6% and realized an unlevered IRR of 7.9%.
Largely due to the timing of dispositions, we are decreasing our disposition guidance for 2018 from approximately $200 million to approximately $150 million. In September, we increased the dividend for the 98 time in our Company's history. Our current annualized dividend represents a 4% increase over the year ago period.
We have increased our dividends every year since the companies listing in 1994, growing the dividend at a compound average annual rate of 4.6%. We are proud to be one of only five REITs in the S&P High Yield Dividend Aristocrats Index.
To wrap it up, we are pleased with the current state of the company and remain excited about our prospects moving forward. Our real estate portfolio, acquisitions pipeline and balance sheet remain healthy, contributing to favorable risk-adjusted earnings growth for our shareholders.
At this time, I'd like to open it up for questions. Operator?
Thank you. [Operator Instructions] And we will go first to Christy McElroy with Citi.
This is [indiscernible] on for Christy. Wondering if you could provide some color on any additional acquisitions and process that are on contract currently, just to get a better sense for timing at the end of the year. And based on opportunities you're seeing in the market today, would you expect a similar pace of acquisitions in 2019?
So as we've always indicated acquisitions are very, very difficult to forecast year out. What I can share with you, that in the fourth quarter we have a very healthy pipeline. We feel very confident about meeting our $1.75 billion guidance. We will probably exceed it by a bit. But at this point to talk about what we are planning on doing in 2019 will be premature.
Okay, great. And then just one quick follow-up on the dispositions during the quarter. Was there anything in particular that drove the cap rate a bit higher this quarter and what should we expect as far as pricing for remaining asset sales in the balance of the year?
The cap rates are largely driven by the types of assets that are being sold. We did reduce our guidance from $200 billion to $150 billion and that was largely being driven by timing and some opportunistic sales that we pulled from the market. So we feel like, our IRR should be right around 8%, which we have historically achieved and should be able to get to $150 million in sales by the end of the year.
Okay, great. Thank you.
And next we will go to Karin Ford with MUFG Securities.
Hi, good morning out there. Sumit, congratulations on the new role. The Company's last two press releases both mentioned that you'd be working with the Board to evolve the company strategy. Can you elaborate what that evolution might entail? And could we see – be seeing investments in new asset classes or a change in the way management looks to create value for shareholders?
Thank you for your question, Karin. What I would want to emphasize is that we will continue to execute on our current strategy as we believe the market remains very strong for the product that we are pursuing. And that was quite evident in the results that we achieved year-to-date as well as in the third quarter.
The team that we have in place here has largely been together for the last five years and was the architect and devised the current strategy that we have in place that we've been executing quite successfully. Having said that, we are always looking for new avenues to grow. Four or five years ago, six years ago, we entered into the industrial market. Right along then, we also explored agriculture and ended up making an investment in Napa Valley.
So to look at new avenues of growth is something that we are constantly doing and we’ll continue to do so. But having said that, we believe there's enough runway in our current strategy and we feel very confident of meeting growth rates on a risk adjusted basis that will be viewed as appropriate for this company.
Thanks for that. My second question is regarding investments. You've had a lot of successes here with corporate sale leasebacks. Do you think that could continue into next year or do you expect the changing lease accounting rules might reduce demand for those deals?
The changes in the lease rules have not impacted our discussions with our relationship tenants. In fact, if anything and we've spoken about this in the past, the viable market for sale leaseback continues to grow and continues to grow with tenants that traditionally wouldn't engage in those conversations. So our take on our pipeline for 2019, the current discussions that we're having with our existing relationships and some new relationships lead us to believe that the lease changes will have a very – will have no impact and the market, the viable market for sale leaseback will continue to grow.
And our next question will come from Vikram Malhotra with Morgan Stanley.
Thanks for taking the question. Sumit, the last time you had a very attractive cost of capital? Maybe 2 years ago, you chose to buy higher quality to a lot of drug stores, that exposure in certain areas. Just wondering now you’re sitting here relative, you have a very good cost of capital to maybe other REIT asset classes. What do you plan to do with it maybe similar and maybe different?
Well, what we hope to believe is that the higher cost – the lower cost of capital that was afforded to us was a function of the strategy that we had implemented and what we had highlighted to the market as the types of retail products and the industrial products that we were most interested in.
And the fact that we've continued to be quite successful and once again find ourselves with a very low cost of capital. On a relative basis, we've always had a low cost of capital and if you look at what's happened over the last three to four years, the cost of equity for us has been on a relative basis amongst the lowest. Now with these two upgrades, the cost of debt has become even lower than most of our peers.
So on a blended basis, we've always had the advantage of having a very low cost of capital. I don't think that that necessarily comes into the calculus in terms of defining what a strategy needs to be. We want to be very true to anything. We believe we have a strategy in place that allows us to create a balance sheet and a portfolio that can do very well regardless of what the economic conditions are.
And we are going to continue to do that. And the fact that we have a very low cost of capital today, I don't think necessarily is going to change the strategy that we have in place and some of the other avenues that we are continuing to explore, given what we find in the cost of capital.
Okay. And then just – second question I know we've talked over the last couple of weeks on this and I think everyone's just trying to get a better sense of how this change occurred? How it was taught about it seemed a bit sudden in terms of John's departure.
So I'm just wondering if you can give us some sense of how this was being contemplated anymore – more thoughts on just the discussions and maybe just to build off of one of the earlier questions on. I know you'd said nothing too different, but maybe what would you be doing incremental from here?
So to answer the question around the suddenness, I mean this was a decision that the Board and John mutually agreed upon. These are discussions that oftentimes happens. When you think about is there a good time for a change and see that never it really is.
And – but the Board and John mutually agreed to part ways, the Board believe that making the transition now is in the best interest of the company and its shareholders and given the depth and strength of our management team and it was believe that doing it now versus down the road was the right decision.
The speed question that you raised Vikram, I've said there are two schools of thought on that one, which is the more traditional route where you typically have a three to six month transition period. And that works in a situation where the incoming CEO may not be immediately ready to take on the reins.
But in this case, both the Board and John concurred that I was ready to take on the reins and incorporating a transition period would have just delayed the inevitable. So from what's transpired, I think that should pretty much address how things have come about.
In terms of what I'm going to do differently, the advantage that I've had is, I've worked with this team and have been part of this team for the last seven years and this team by and large has been intact for all of that time.
I've been along with the team very much part and parcel of defining the strategy and then executing on the strategy. So there's a sense of continuity that we continue to have and that is going to bode well.
So if you're looking to see for any dramatic changes in terms of how we’re going to conduct business, et cetera. I don't believe, you're going to see that. So its business as usual and what I might do slightly differently is be on the road a little bit more, be a bit more visible in terms of meeting shareholders, et cetera.
And in terms of internally, and I think I've mentioned this in some individual conversations is have a flatter organizational structure where my connectivity with my direct reports i.e., all of the EPVs in the company, is going to be, just have one degree of separation. So those are very minor changes. But that's more in line with how I would like to run the Company, but in terms of strategy, et cetera. It's business as usual.
And next we’ll go to Todd Stender with Wells Fargo.
Hi Sumit, congratulations on the promotion.
Thank you, Todd.
When you look at the 7-Eleven acquired in the quarter were these sale leasebacks and can you describe the lease terms, these are rent escalator, rent coverage, just some of the specifics? Thank you.
Sure. Yes. These are all sale leasebacks. I sort of alluded to the fact that we get very good pricing. I would go so far as to say that the pricing that we get on sale leasebacks that we are doing directly with 7-Eleven is in the tune of around 75 to 50 basis points higher than what you would get in the one-off market. They are 16-year average lease terms and they have a 7.5% growth every five.
Okay. Thank you. And then Paul just looking at the balance sheet, your line balance was getting up close to $800 million just at the end of Q2, but that was on the $2 billion line and that used to be a big number, but relative to the size of the company, maybe not so. But on a $3 billion line, could we see that balance grow even higher? It may look on an absolute basis large, but maybe on a comparable basis, not so much. But how big that the line balance for you guys get?
So I think that's fair to consider from an overall risk management standpoint and variable rate debt exposure. These are relative to our peers and/or how we view the balance sheet. Keep in mind that the larger line was more a function of giving us the liquidity and flexibility on the acquisition front that we thought was appropriate as opposed to trying to foreshadow any change in balance sheet philosophy.
Relative to the current balance on the line, I'll remind everyone that we closed on a $250 million term loan just a week or week or so ago, which then immediately was applied to that line. That was a funded term loan. And in addition, we have some property sales activity in the fourth quarter. So from a funding standpoint, the line balance will not be a very large.
It's currently, as of a week ago was under $600 million after that term loan repayment. And we're not in a position where we need to access capital for any particular reason because our leverage metrics are very good as well. But all forms of it are available to us and we'll be taking a look at all forms of it on a go forward basis, but we're not in a position right now where we have any immediate funding needs.
And we’ll go next to Collin Mings with Raymond James.
Thanks and congratulations Sumit.
Thanks Collin.
Just first question for me, just going back to Karin's question actually. As your platform continues to grow, just maybe how are you currently thinking about international opportunities specifically?
We don't have immediate plans to go international. But like I've said, all avenues are on the table and we continued to look at avenues of growth of which to ignore international would be, wouldn't be correct. But we don't have any immediate plans to go international.
And like I've said, Collin, we believe we have enough runway in executing our current strategy that gives us comfort that any one of these new avenues that we come up with, we will have time to test it, make sure that this is something that fits our overall strategy of conservatism and risk adjusted growth rates, and at the appropriate time we'll be ready to speak with the market about it, but no immediate plans.
Okay. And then on – as far as the 7-Eleven, you touched on the cap rate differential between what you think the pricing would be on the one-off market versus, again being a portfolio. Like you suggested, maybe 75, 50 basis points. Just maybe making a little bit broader picture here, how are you thinking about the portfolio premium or discount in the marketplace right now and at maybe what threshold of – in terms of deal size do you start to see that really take effect?
Look over 80% of what we did was sale leasebacks this particular quarter. And what we're finding is with these large institutional tenants that we have very deep relationships with. They are very open to having discussions around adjusting cap rates to accommodate the changing cap rate environment and that accrues to our favor. The fact that we've been able to do north of $1 billion of 7-Eleven in the last two years and get cap rates that are off of the one-off market to the tune of 75 basis points speaks to that point. So we feel like that there are discounts that we get by entering into these portfolio transactions, especially with sophisticated institutional tenants.
And we’ll go next to John Massocca with Ladenburg Thalmann.
Good afternoon. And first off, congratulation Sumit on the new role.
Thank you, John.
So were there any other tenant industries that particularly dominated this quarter's acquisition activity? I know with the 7-Eleven, obviously, C-stores would be one of them, but anything outside of that?
There were C-stores and restaurants. Those were the two dominant areas of industries.
And my second question here, were those casual dining or QSR?
Casual dining.
Okay. And then does the current strategy leave open the potential for M&A activity, especially given the strong cost of capital? Or are you really still primarily focused on what you've done in the last couple of quarters in terms of larger sale leaseback transactions and given how strong that market has been for you guys?
Yes. Look we control the discussion around the sale leaseback market. These are organic acquisitions that have served us very well over the last few years. M&A is something that we don't count on and that's not to say that we are averse of doing M&A transactions. This Company has had a history of having done some of those, but that is not something that we control and we don't count on that. We are very happy with the runway that we have executing our current strategy and the numbers speak for themselves. So John, if you're asking this is something that we are aggressively going to start pursuing, then the answer is no, but we're not averse to M&A either.
Color is very helpful. Thank you very much.
And next we'll go to Christy McElroy with Citi.
Hey, it’s Michael Bilerman here with Christy. So the question is just regarding the CEO transition. So did john get a bonus for 2018 or an accrued bonus relative to his comp level?
The severance was largely negotiated Michael and it was in line with his – the agreements that were in place as well as his employment agreement. So the 28 – approximately $28 million that we have listed was pretty much in line with his employment agreement and the agreement around his stock awards.
I mean, if you read the proxy, it was generally in line with that, but we're sitting here in November effectively not – from a timing perspective, why would he agree to forego $10 million of a bonus if he worked basically until January 1 of next year. And I don't know many people that would give up $10 million, whether he could have rolled into next year and then decided to do it?
No, the fact that we – I think we’ve also just highlighted the fact that $9 million of it had already been accrued. So you can pretty much assume that what had been accrued for this year was part of the $28 million that was paid out. So I don't believe it's accurate for you to assume that his pro rata share, he had to forego that.
End of Q&A
And this does conclude the question-and-answer portion of Realty Income's conference call. I will now turn the call over to Sumit Roy for concluding remarks.
Thank you, Caroline, and thanks everyone for joining us today. We look forward to speaking with you all at NAREIT conference next week. Thank you.
That will conclude today's conference. Thank you, everyone. You may now disconnect.