Realty Income international expansion conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Andrew Crum, Senior Associate at Realty Income. Please go ahead, sir.
Thank you all for joining us today to discuss Realty Income's international expansion and GBP 429 million sale leaseback transaction with Sainsbury's. Discussing this strategic transaction will be Sumit Roy, President and Chief Executive Officer. 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. Supplemental materials are available on the company's website. We will be observing a two-question limit during the Q&A portion of the call in order to give everyone the opportunity to participate. If you wish to ask additional questions, you may re-enter the queue. I will now turn the call over to our CEO, Sumit Roy.
Thanks, Andrew. Welcome to our call today. We are excited to announce our company's international expansion, which supplements our robust domestic investment pipeline and represents a natural evolution of our company's strategy. We are ideally positioned to pursue additional growth opportunities in the U.K. and mainland Europe, given our position as the leader in the net lease industry, our sector-leading cost of capital, and our ability to complete large-scale sale leaseback transactions without creating tenant or industry concentration issues. We believe the addressable market in the U.K. and mainland Europe is extensive, with significant demand from high-quality tenants for sale leaseback capital on reasonable terms. While this is an attractive financing option for corporate partners in the U.K. and mainland Europe, there are no large-scale pure-play net lease capital providers to fulfill that demand.
This creates an opportunity for us to expand our addressable market while staying true to our existing investment criteria. Our international expansion is an extension of our company's existing mission as we remain cognizant of the values which have dictated our prior successes. Accordingly, we are excited to announce our first international transaction with one of the top operators in a defensive, non-discretionary industry that has proven to be resilient throughout economic cycles. We have signed a definitive agreement with Sainsbury's and British Land to acquire 12 properties located in the U.K. for GBP 429 million at a 5.31% initial cap rate. The 12 properties are net leased to Sainsbury's with a weighted average lease term of approximately 15 years and include annual rent increases for the duration of the lease.
Sainsbury's is one of the leading grocery operators in the U.K., with over 1,400 grocery and convenience store locations across the U.K. and Ireland. We are pleased with this relationship-driven transaction as it was negotiated on an off-market basis, and we expect to close on the transaction over the next 30 days. Our size, scale, and cost of capital enables us to execute this transaction at investment spreads relative to our first-year weighted average cost of capital of approximately 210 basis points, which is 60 basis points above our historical average. On a leverage-neutral basis, this transaction will add approximately $0.04 per share of annualized AFFO accretion. Accordingly, we are increasing our 2019 AFFO per share guidance from a range of $3.25-$3.31 to a range of $3.28-$3.33.
We are also increasing our 2019 acquisition guidance from a range of $1.5 billion-$2 billion to a range of $2 billion-$2.5 billion. We estimate the size of the commercial real estate market in Europe to be approximately $11 trillion, with $30 billion-$35 billion of annual single-tenant transaction volume in our core verticals. Similar to the dynamic we have experienced in the U.S., we believe there is a significant opportunity to be a sale leaseback capital provider to owner-operators who are seeking to unlock the value of real estate they hold on their balance sheet. Of the 6,000 listed companies in Europe, the median EBITDA multiple is approximately 7 times, which implies that these companies can create meaningful value by selling and leasing back their real estate and reinvesting the capital into their core operating businesses.
Over time, we expect to leverage our competitive advantages of size, scale, and cost of capital to judiciously grow our portfolio in Europe. The U.K. is a natural market for us to incubate our investment activities abroad, given the liquidity of its commercial real estate market and strong underlying real estate fundamentals. We estimate the potential size of the sale leaseback market in the U.K. to be over $1 trillion. High population density and limited real estate supply growth creates a compelling opportunity for long-term real estate investment. The current population of the U.K. is approximately 67 million, roughly equivalent to the size of California and Texas combined. However, the land area of the U.K. is less than 94,000 sq mi, approximately the size of Oregon. Retail square footage per capita in the U.K. of 5 sq ft is significantly below levels in the U.S. of 24 sq ft.
The U.K. has also demonstrated long-term macroeconomic stability. U.K. retail sales have grown at a compound average annual growth rate of 2.5% since 2000, which compares favorably to the broader EU at 1.2%. U.K. GDP growth has been stable. Household disposable income continues to increase, and current unemployment of approximately 4% is the lowest in over 40 years. Brexit continues to create uncertainty, we believe this uncertainty could generate additional opportunities, particularly where a tenant's business model is driven by sales of non-discretionary goods. Over the past 15 years, grocery sales in the U.K. have consistently grown, both as a percentage of total retail sales and nominally at a compound average annual growth rate of 2.5%. Historical commercial real estate investment volume in the U.K. also demonstrates the stability of the U.K. commercial real estate market.
Over the past 15 years, the average annual investment volume in the U.K. commercial real estate market has been over GBP 50 billion. We believe the resiliency of both the commercial real estate market and the U.K. grocery market makes it a viable market for long-term real estate growth. Moving briefly to our investment thesis on Sainsbury's as a partner. We view Sainsbury's as a top operator with a track record of consistent performance with demonstrated resiliency throughout several economic cycles. During the Great Recession, Sainsbury's maintained healthy same-store sales growth, improved EBITDA margins, and reduced leverage. Sainsbury's same-store sales grew at an average annual rate of 4.7% from 2007 to 2010, significantly outperforming U.K. retail and GDP growth over the same period. With 150 years of operating history, Sainsbury's is one of the top three largest grocery operators in the U.K.
In 2018, Sainsbury's generated over GBP 28 billion in revenue and approximately GBP 800 million in free cash flow. While Sainsbury's is not currently rated due to a lack of public debt, the company has implied investment-grade credit rating based on our analysis using the S&P credit methodology. Pro forma for the transaction, Sainsbury's will be our 12th largest tenant, representing 2.2% of revenue. Regarding the grocery industry, we continue to favor the defensive nature of the business model, selling non-discretionary consumer goods. The grocery industry is familiar to us as our seventh largest industry at year-end 2018, representing 4.9% of revenue. Pro forma for this transaction, the grocery industry will be our fifth largest industry at approximately 7.1% of revenue.
The U.K. grocery industry accounts for approximately half of all U.K. retail sales and is concentrated among the top four operators in the space, who control approximately 64% of the market share. Our partnership with the top operator in the industry is consistent with our existing grocery industry investment criteria in the U.S., where our exposure is largely concentrated with the top two operators, Walmart and Kroger. We remain positive on the grocery industry and believe our exposure to the U.K. grocery industry will be additive to the existing quality of our portfolio. The portfolio we're acquiring consists of high-quality real estate locations in stable markets. The average population within a 15-minute drive of the 12 assets is approximately 116,000. The average household income around our portfolio is approximately 8% above the U.K. average household income. The quality of the real estate locations is further demonstrated by the store-level performance.
The estimate cash flow coverage on the portfolio of assets is above three times, which is above both our portfolio average as well as our grocery industry average. This provides a strong margin of safety with an estimated drop in sales to breakeven of over 20%. The estimated sales per gross square foot for the portfolio is approximately GBP 550, which is 14% higher than the U.K. average. Strong store-level performance in quality real estate locations adds to long-term cash flow stability. Given our favorable cost of capital and lower borrowing cost for pound-denominated debt, we expect investment spreads of approximately 210 basis points relative to our leverage-neutral nominal first-year weighted average cost of capital. Additionally, the current strength of the dollar against the pound creates a compelling investment opportunity with the current FX rate approximately 20% below the historical median.
To hedge the foreign exchange risk associated with our pound-denominated investment and the net cash flows generated from our U.K. operations, we expect to finance approximately 70% of this transaction with pound-denominated debt, with our equity investment hedged with a cross-currency swap. The tenor of these instruments is expected to be 15 years, consistent with the initial lease term of our investment. Our cross-currency swap will allow us to exchange our forecasted pound-denominated cash flows for a fixed U.S. dollar coupon that will be determined based on the forward FX curve at the inception of our hedge. As a result, we expect our exposure to fluctuations in the value of the pound to have a minimal effect on our U.S. dollar cash earnings for the duration of the lease.
Given the slope of today's forward exchange rate curve, the duration of these leases, and fixed rent bumps throughout the duration of the lease, we expect to realize a base case unlevered IRR in the mid 6% range, which exceeds our long-term WACC using low-yielding pound-denominated debt. These returns are favorable given the quality of these assets and the strength and stability of the tenant. We're excited about the next chapter in our company's history. Even as we expand our addressable market internationally, our domestic pipeline remains active. Since 2013, we have sourced an average of 31 billion domestic transactions annually, completing an average of $1.6 billion in acquisitions. We continue to see sufficient domestic acquisition volume to grow our business, and our international platform will be additive to our existing pipeline.
As we grow this aspect of our business, we expect to establish a team in London and will leverage our U.S. business for certain functions. We expect our team in London to be fully staffed with our employees, some of whom will relocate from our U.S. business. As we continue to grow, we will manage the business with the same emphasis on generating stable cash flows that grow over time. We have always maintained a conservative capital structure and stringent investment guidelines, and these values will continue to dictate how we manage the business. Thank you. We'll now open it up to any questions. Operator?
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach your equipment. Please limit yourself to two questions. If you would like to ask additional questions, you may re-enter the queue. Once again, that is star one if you would like to ask a question. We will take our first question at this time from Nicholas Yulico. Please go ahead.
Greg McGinniss on for Nick. For my first question, I'm just kind of curious what you're thinking about in terms of the investment split going forward. If you're expecting to spend $2 billion next year on acquisitions, how should we think about that split between U.K., broader Europe, and the U.S.?
Nick, sorry about that. We lost your question. Could you just repeat it? We had some technical issues on this side.
Sure. Sorry. This is actually Greg McGinniss on for Nick. I'm just kind of curious about how we should be thinking about the investment split going forward. For instance, if you have $2 billion of acquisitions next year, what kind of split are you looking at from a U.K., broader EU, and a U.S. investment?
Thank you, Greg. Predominantly, we are very satisfied with the pipeline and what we see here in the domestic market. Most of the guidance that we have come out with, when we came out with our guidance earlier this year of $1.5 billion to $2 billion, it was 100% domestically driven guidance. The reason why we upped it was to accommodate this particular transaction. We are very positive on this being the first of many transactions in the U.K. as well as in mainland Europe. We've done a fair amount of study to figure out the depth of the market, we were very cognizant of the fact that if this were to be just a one transaction deal, that we wouldn't have gone forward with it.
We believe the market is there for the product that we look for at economics that make a lot of sense for us. It would be premature for me to give you guidance in terms of what we think, what portion of our forward-looking guidance going into the future will constitute the U.K. and mainland Europe today. Of the $2.5 billion, the $2 billion-$2.5 billion that we have guided the street to for 2019, clearly $550 million of that is going to be the U.K. transaction.
Okay, thanks. That's fair. Just for the second question, with the opening of the new office, I'm just curious how much you expect the launch of this new platform to impact G&A expense.
Look, we are singularly focused on G&A. I think there was a variance of that question that had been asked by Michael, I believe, in our last call. We are still guiding to a sub 5% G&A margin for all of 2019. The reason why we are able to accommodate a transaction of this size, absorb setting up the infrastructure, et cetera, and still come in at less than 5% G&A margin is our size. We are still going to target that particular ZIP code.
All right, great. Thank you so much.
We'll take our next question from Christy McElroy at Citi. Please go ahead.
Hey.
Hey.
It's Michael Bilerman here with Christy. Sumit, I assume Michael was Michael me or a different Michael?
Michael, it's always Michael you.
I know, I get it. I'm now like Madonna and Oprah. It's great. I guess you did the currency swap. Why not just redo your line of credit to have a euro and pound denominated feature to effectively 100% leverage your foreign investments to be perfectly matched that way?
It was more of a timing thing, Michael. We are in fact going to engage with our main lenders on our line to accommodate a portion of our $3 billion line to both EUR as well as GBP denominated credit facility. Given how quickly this transaction came about, once we decided and once we had done all the strategy work that this made a lot of sense for us to sort of embark upon, we just didn't have the time to accommodate a change to the credit facility within the timeframe that we've had this transaction come about. That is something that we are absolutely going to be doing over the next 3 months.
Maybe just walk us through the timing of, A, the education process you went through and then the specific deal. I think they were down to 16 stores in the partnership that dates back well over 15 years between Sainsbury's and British Land, having sold a lot of the assets. I don't know if you particularly left 4 out or if they had sold those 4 separately. I don't know how you were dealing with the securitized debt on the portfolio also. Maybe you can just walk through the education process you went through when this deal came about, and then the assets and the debt on them.
Sure. We did a fair amount of our strategy work, I want to say, the fourth quarter of last year, where we were looking at the U.K. and mainland Europe and trying to figure out, is this an area that we should look to grow? Does it make sense from an economic perspective? Is there enough volume, et cetera? After having done our work and working with external advisors as well to make sure that our thesis was supported, we decided to look for transactions. We spoke with British Land and Sainsbury the later part of December, early part of January, and started talking about what they wanted to do with this particular JV. British Land had publicly stated that they wanted to unwind the JV, and Sainsbury, post our discussions with them, was very amenable to partnering with somebody like us on a long-term basis.
We kicked out a couple of assets that was part of the JV, just given the location and given the performance of those particular assets. It just wasn't a good fit for us. We actually redid the leases to accommodate our need of getting to a 15-year lease term on a net lease basis with annual rent bumps. If you look at the original JV and look at the leases that they had in place, that is not the leases that we are going to essentially have entered into with Sainsbury. This was done as part and parcel of doing this transaction. With regards to the secured debt that is already on this JV, that will be handled by British Land and Sainsbury. We agreed on a price, and they're going to unwind the debt.
They are within the call period of the unwind, which is why the transaction was structured to sort of fall into this particular timing. We will get unencumbered assets. The way we are financing this transaction is with GBP 300 million unsecured private placement debt and GBP 129 million-GBP 130 million of equity . We have entered into a currency swap on both the principal amount, which is the GBP 130 million for a 15-year duration, as well as the cash flows over the 15-year lease term with the embedded growth in it. Our dollar-denominated cash flow is established day one with very little, 85% of our annual cash flow has this swap arrangement or this hedge arrangement with 15% of the cash flow that will be subject to some level of volatility.
We believe that overall, we have very good visibility into the dollar-denominated cash flow that we'll be repatriating, and therefore can say with a high level of confidence what our AFFO per share impact was, which is at $0.04 annually.
Yeah.
I think I answered most of your questions. If I missed some, please go ahead.
No. I've already violated the two-question limit. Thank you for the time.
Thank you, Michael.
We'll take our next question from Rob Stevenson with Janney. Please go ahead.
Good afternoon, guys. Can you talk about, a little bit, how you guys underwrote Brexit into this and what the dislocation could wind up being to these assets economically as a result of that, whether or not you factored that in and got some sort of essentially Brexit discount by doing this now, given some of the uncertainty?
Look, I think on a macro level, it would be disingenuous for me to say that because of the uncertainty around Brexit, you have the impact that you do on the interest rate side, you have the impact that you do on the foreign exchange side. All of that ultimately accrues to our economic benefit. At a very macro level, this uncertainty has actually worked in our favor, economically speaking. We did a fair amount of work, Rob, on trying to figure out, in the event of a Brexit, what are the different scenarios that could play out. One could be an orderly Brexit, one could be an disorderly Brexit, and how do all of those different scenarios play out. Today, we actually have a fair amount of visibility that, okay, it's been extended to October 31st.
While we were underwriting this transaction, there were multiple scenarios that we underwrote. The expectation today is that it will be an orderly Brexit. There will absolutely be some level of impact to the grocery industry, but it's not going to be disproportionate to Sainsbury's. Each one of the grocers, the top four grocers, will be similarly impacted. In speaking with the CEO and the management team at Sainsbury's, they have already taken steps to get ahead of this eventuality, from stockpiling hard goods. Approximately 30% of what the U.K. grocery items are sourced from continental Europe.
Whatever it is that they could stockpile of that 30%, they have done so, and they're looking for alternative sourcing for things that they may have to locally source. In some cases, they'll have to come up with a different strategy, especially around the fresh produce that cannot be locally sourced. Given all of that, we felt that the appropriate steps have been taken by Sainsbury's to get ahead of this. What gives us a lot more comfort as well is when we did the analysis at the store level, we estimated that the sales to break even of our portfolio of over 20%, which provides a significant cushion. Our stores are expected to be resilient even in the worst case scenario. We looked at how Sainsbury's had done in 2008, 2009, and they continued to outperform during that timeframe. We get it.
Brexit is different. We feel very confident, both the discussions that we've had with the management team, the store level profitability of these assets, that Brexit, though an uncomfortable situation, Sainsbury's has gotten ahead of it and will come out okay.
Okay. I think you gave cash flow coverage of over three times and $515 per sq ft of sales. How do these assets rank in terms of productivity of their stores? I guess the other question would wind up being, is the lease that you guys signed with them protected for any type of divestiture in this Asda merger that could potentially go through or fall through over the next couple of months?
Yes. We obviously looked at their current acquisitions or potential acquisitions of Asda. I'll answer that question first, then I'll go back to the store level performance and how we came up with that. Given where the CMA is today on the Asda acquisition, it is highly unlikely that will go ahead. If this were to happen, and there were to be store closures or divestitures as you said, we are going to be protected. We spoke with Sainsbury's about that particular scenario. We have a 50-year lease with them. It is really up on them to try to come up with a solution on the assets, in the event that they are being asked to divest those assets. Based on everything that we are reading, based on our conversations with the management team, it doesn't seem like the Asda transaction is going to go through.
That could change. We'll know a lot more, I believe, towards the end of April. That is the current thinking on that front. With regards to the profitability of each store, yes, our estimates are that these are north of three times coverage. The sales per gross square feet, I want to make that point because the U.K. looks at it on a net basis. We translate it to gross. It is 550, not 515. It is north of the overall average of 480, I believe is what the number is. These are definitely above average stores in terms of if you look at the Sainsbury's system, in terms of both sales as well as profitability. We feel very comfortable that on average, this particular portfolio is incredibly healthy.
Okay. Thanks, guys. Appreciate it. Have a good night.
You too.
We will take our next question from Vikram Malhotra at Morgan Stanley. Please go ahead.
Thanks for taking the question. Sumit and team, congrats. I know you guys have been doing a lot of work on various things, so congrats on at least making the decision and going forward. Just on the market as you described it in the presentation, the overall size. Any sense of, A, the split sort of between the U.K. and everything ex-U.K.? Within that, just can you talk a little bit about how you viewed industrial versus retail and office?
Yeah. Sure. Thank you for that, Vikram. We did a fair amount of work in terms of sizing this particular market, we split it up by U.K. and mainland Europe. I think we have some information on what it is that the U.K. market will bear. By and large, we believe that if you were to combine the U.K. and the European market, we should expect to see in that $30 billion sourcing number, which will include all asset types that are net leasable. Within that split, I think it's probably maybe $10 billion to $12 billion in the U.K. and the remaining in mainland Europe. We have been very averse to going down the path of pursuing office assets here in the U.S. for obvious reasons, I don't have to get into that.
Our focus is going to be to stay in the industries, stay in the asset types that we feel most comfortable with, which will be retail and industrial. I believe that the number that I just shared with you, the $30 billion to $35 billion, actually excludes all office assets, net leasable office assets. That's the domain that we feel most comfortable with. If we can grow our retail portfolio or our industrial portfolio in a very similar fashion to how we've done it here in the U.S. where largely we are out of the industrial market, just given the pricing. We'd love to be able to do that.
Okay. Then just curious on competition. One of your peers, W. P. Carey, has obviously been investing in Europe for a while, U.K. as well, in both industrial and in retail as well. Just sort of curious how your sort of strategy over time or focus over time may differ and put you in a different position versus domestic and maybe other international peers.
Yeah. Listen, W. P. Carey is a very respected peer. They have been doing this for a very long time. I think where we deviate is around the type of product that we pursue, and that is the point I'm trying to make, which is when we did our study, it wasn't so much looking at product that W. P. Carey would pursue. They've got a wonderful team, and they're doing a great job there. It's the product that we would like to pursue, which we don't find others of a similar ilk pursuing. This is a perfect example of the type of transactions that we would like to sort of enter into. I would say that we are complementary to each other in terms of the strategy that we are pursuing, in the U.K. and that we would like to pursue in Europe.
Great. Thank you.
We'll take our next question from Wesley Golladay at RBC Capital Markets. Please go ahead.
Hi, guys. Thanks for taking the question. Looking at your required returns, when you go to Europe, you got a nice 200 basis point spread over your cost of capital now, how should we look at that going forward? Does it vary much between the U.K. and Europe?
A lot of it is driven by, not a lot, but certainly some of it is driven by the economic environment we find ourselves in. If you look at the 10-year gilt today, it is right around 1.22, 1.25. You look at where the U.S. Treasury is, it is closer to 2.6. Traditionally, they used to be right on top of each other. We did some analysis, and we found that actually the 10-year gilt used to trade at 20 basis points higher than the U.S. 10-year Treasury. That differential has obviously translated into the forward curves that we are seeing. That translates into being able to raise domestic debt at levels that are potentially 80 basis points, 90 basis points south of what we would be able to finance here in the U.S.
Obviously, that sort of pricing, that sort of cost of capital yields these cap rates that tend to be, if you look at it just in isolation, tend to be, I would call it 50, 60 basis points inside of what we would be doing here in the U.S. Because of the way we can finance it and because of how that translates into our weighted average cost of capital denominated in the U.K. source of financing, it pencils out into very healthy spreads. If your question is how would that change, if we were to do a transaction in mainland Europe, I don't know if it would change dramatically, especially for the kind of products that we are pursuing. I know that in Germany, the rates are even lower.
I am sure that sort of translates right through into the cap rates that we would end up having to buy some of these assets at. Having north of 200 basis points on a leverage-neutral basis, I think gives us tremendous confidence. Being able to sort of, essentially trap it over the duration of the lease term, that gives us a lot of confidence that this is the kind of investment that we would like to continue to do.
Okay. For the future transactions, is there a big difference between the 70% debt stack and the 35% leverage-neutral for the international acquisitions? Are we going to be more towards the 70 or will it eventually find its way to the U.S. average?
Yeah. Wes, the one thing we will do is on a fully consolidated basis, which is why I'm sharing with you the 210 basis points on a leverage-neutral basis. If you were to look at how we are actually financing this and look at the spreads we are going to be creating, it's going to be closer to 260, 270 basis points. Obviously, over-leveraging a transaction in the U.K. means we are going to over-equitize transactions here in the U.S., so that at the corporate level, on a fully consolidated basis, we are not going to deviate from what we believe to be our conservative balance sheet. We're very proud of our A-, A1 credit rating, and on a fully consolidated basis, we are going to continue to manage the balance sheet in that particular fashion.
Okay. That makes sense. That's all for me.
Thank you.
We'll take our next question from Karin Ford at MUFG Securities. Please go ahead.
Hi, good afternoon. I'm just trying to understand the real estate economics separate from the financial benefits you're getting from today's interest and currency rates. Can you tell us what the initial cap rate and IRR are on the deal, not including the foreign exchange benefits, and how they compare to what you think you could achieve on similar U.S. grocery and credit investments?
I'll answer your last question first, Karin. On a similar deal here in the U.S. in grocery, we would be in the low 6% IRR basis. As you can tell, we are being able to achieve 6.6% IRR on this particular transaction. If we were to take the economics that sort of accrue to us due to the foreign exchange and the hedging that we have put in place, I would say that this would be right around where we would be doing a grocery store deal here in the U.S. From a pure economic standpoint, clearly the macroeconomic environment that we find ourselves in is accruing to our benefit.
Even absent that, this particular transaction would pencil and would be right on top of what we have traditionally done in the high-end grocery business, and that would be partnering with folks like Kroger and Walmart Neighborhood Market.
That's helpful. Thanks for that. My second question was, I think you said there's a fixed escalator on the lease. Can you just disclose what that number is? Will you be targeting both Eastern and Western Europe in your pipeline?
Good questions, Karin. I actually am not at liberty to disclose what the annual growth rate is, suffice it to say that it is well north of what we have given guidance to in terms of same-store growth rates, which is right up around 1%. Obviously, that too has a very positive impact in our IRR calculation. With respect to Eastern Europe and Western Europe, if we are able to grow into Eastern Europe through our partners that we believe are the right partners to enter into transactions with, we are not going to be averse to doing that. It's just, it is going to be driven off of our relationship and who do we want to partner with in Europe and where do they operate.
We will be a bit more cautious about entering into Eastern Europe versus more of the traditional Western Europe markets that have a lot more similarities to the U.S.
Thanks for the color.
As a reminder, that is star one if you would like to ask a question. We will take our next question from Todd Stender with Wells Fargo. Please go ahead, sir.
Thanks, Sumit. Looks like Sainsbury's owns both supermarkets and C-stores. You guys are, I guess, just buying the supermarkets. Ten of the 12 have gas pumps. They're also in the five, six, seven acres each range. Can you just talk about maybe what's different about these properties from maybe what we characterize grocery here and C-stores? Thanks.
Actually, it's not that different. If you look at some of the Walmart Neighborhood Market, they have gas pumps as well. You're absolutely right, Todd. These are not convenience stores. These are their supermarkets, all 12 of them. Ten of them have gas pumps, and actually, five of them have car washes. What we found when we visited these stores, that those avenues are essentially just to help drive foot traffic into the store. This is not very dissimilar from what a Costco does, having a gas station, which is not necessarily a money-generating mechanism, but something that allows them to draw traffic. Not that Costco needs that, but it's a similar concept with Sainsbury's. If you go into one of these Sainsbury's, you'll find cafes inside the supermarkets. That, too, is completely run and operated by Sainsbury's, but not necessarily a profit center.
It's more to continue to pull in traffic, and ultimately it translates to obviously higher sales per square foot. Those are numbers that we've shared. That's the dynamic.
Thanks. Then just sourcing the equity. Is the deal include any OP units? Is that in your call, $130 million of equity? Is this going to be sourced through the ATM, or timing is uncertain, and you'll just probably close with your line and equity comes later? Maybe just some color there.
Yeah. This is a pure fee simple. We're going to own 100% of these assets. There is no remnants of a partner staying on this transaction. That would have overly complicated the situation for us. All of the equity, like you said, will be initially financed off of our line. We'll look at the capital markets to figure out what's the right avenue downstream. We are really looking forward to announcing our first quarter numbers next week, and we can get into a little bit more of financing, et cetera, at that point.
Thank you.
Thank you.
We will take our next question from John Massocca . Please go ahead, sir.
Good afternoon.
Hi, John.
Thanks. Would you expect kind of future transactions in Europe to, as you build out operations in London, be more granular? Will future transaction activity continue to be larger deals like the one with Sainsbury's, and it's just a means for you to asset manage those properties?
It's the former. I think it's going to be a combination of how we did this particular transaction. My hope is that now that it is public, people will see how they could use the sale leaseback avenue to partner with somebody like us, to continue to do these large-scale transactions. We will also create the infrastructure to do one-off transactions, just like we have here in the U.S. It goes back to Michael Bilerman's question earlier on around, why wouldn't we have accommodated a British pound/euro denomination in our line, and that is absolutely the path that we are going to undertake. It will be our source of temporary financing. One-off transactions all the way through to doing large-scale transactions with corporate partners, that will be the goal.
Understood. How long do you think it's going to take to have that London operation fully up and running? It just seems maybe a little bit awkward that the first transaction gets announced before there's infrastructure in place to sustain additional transactions. Is it just something that will be a quick ramp here over the next couple of months, or is it going to take maybe into some point in 2020 before that office is fully up and running?
Actually, I failed to answer one of your questions, and I think the answer to that question will help with your second question. You talked about asset management. There is none. These are triple net leases that we're going to have in place. Our involvement, over the duration of the lease, is going to be very minimal, if at all. We just need to make sure that we're collecting our rent. The team that we are going to be creating, is essentially going to be working on establishing the relationships and building on the relationships that Neil and Mark and the rest of the team here have sort of already undertaken, and building on that. Then, trying to source more transactions. How we finance those transactions, that will be step one, if you will.
We're obviously going to leverage the infrastructure that we have here to a large extent to help with supporting the IT requirements, the financing and accounting work, the tax work. We will have some local partners initially who are going to help us with that we've already entered into contracts with or are in the midst of entering into contracts with. All of that is going to get housed here. From an IT perspective, because of the way we've set up our infrastructure, we're essentially a cloud-based firm, and that allows us tremendous flexibility to set up an office. I have been told by Joe, who runs our IT department, that he can have an office, a satellite office, up and running over a weekend.
Those are steps that we have taken over the last so many years to essentially get to a point where we can do these types of things. Now, of course, it's accruing to our benefit. The idea is, within the next six months, to have someone, and we already have some volunteers. I look at Austin, who's part of our acquisitions team, who is going to be moving to London, to essentially seed the company. That shouldn't take too much time to get office space, to have him up and running, and then just transition all of the relationship work that Neil and Mark have been working on to Austin so that he can be up and running.
At that point, I think either you asked the question or someone else did, we are essentially going to be pursuing very actively all of the different avenues that we've talked about.
All right. That's it for me. Thank you very much.
Thanks.
We will be taking a follow-up question from Christy McElroy at Citi. Please go ahead.
Hey, good afternoon, everyone. You had made a point, Sumit, about the owner staying in the deal. Just given that Sainsbury's was a 50/50 owner with British Land, was there a discussion about them staying in as an owner on this deal? How do you see the trade-off between there maybe being a greater level of comfort with them still being an owner versus it creating more complexity, as you said?
Yeah. Actually, I looked at it slightly different, Christy. I wanted to own, this was our collective belief that, listen, this is our first foray into the European market. Having a JV structure just complicates the situation. I totally understand where you're coming from. The advantage of having them as owners, one would have made the argument that creates a bit more alignment, et cetera. For us, there was a little bit of a push and pull when we said we want to own these assets 100% fee simple. One part of Sainsbury's obviously was going to try to negotiate a price where they had the 50% of the proceeds or whatever the JV structure was. The other side of it was we were entering into new leases where occupancy cost was equally important to them. We felt that that inherent tension actually worked in our favor.
By the way, Sainsbury's as a partner was tremendous to work with. They were all focused on exactly the same things that we would want our partners to be focused on, which was how do we make sure that our occupancy cost is well contained? That was essentially how the conversation went about. We ended up with what we needed, which was 100% ownership and structuring leases in a manner where occupancy cost was as low as we could make it, with Sainsbury's's blessing. I think it worked really well, going through this particular transaction.
What is the cash flow coverage on this new deal versus the prior deal with British Land?
The leases that they had in place on these 12 assets were set to expire, in some cases in four years, in other cases it was a little bit longer than that. We really didn't care so much about what the coverages were in the JV that they had. In some cases, and I think on average, the rents were brought down versus what was currently in place. I think it goes back to the point I'm trying to make, which is on an occupancy cost basis, they were very much aligned with us. They were willing to enter into long-term leases, but they were very focused about our demand for annual rent increases. We ended up in a zip code that obviously we were pleased with as well as they were.
Okay. Just lastly, sorry if I missed this comment, but just in regard to the 210 basis point roughly investment spread on a leverage-neutral basis. As you think about that being higher than your historical average, how should we think about future transactions abroad for you guys in terms of underwriting? Should we expect similar sort of spread thresholds?
Yeah. Christy, I wish I could tell you no, you should expect more. I can't. What I will promise to do is anytime we are doing transactions, we will give you those numbers just like we do on our U.S. acquisitions. What are the spreads that we are being able to achieve? Much of it will be a function of the type of product that we buy. What are we able to structure those transactions at? What is our cost of capital at that particular time? All of that is sort of going to filter in on the spreads that we are going to make. It's virtually impossible for me to sit down here today and give you what we hope we'll be able to achieve.
When we do transactions, please suffice it to say that we're going to be very focused on the spreads that we make. Not just the spreads, but what is the overall return profile of these investments. We will be absolutely happy to share that on a quarter-by-quarter basis.
Right. You're effectively building in a higher return on a risk-adjusted basis on your investments abroad, though, relative to your U.S. investments.
On this transaction, absolutely, yes.
Yes. Okay. Thank you.
This concludes the question and answer portion of Realty Income's conference call. I will now turn the call over to Sumit Roy for concluding remarks.
I'm very grateful for everybody dialing in. I look forward to discussing our first quarter 2019 results next week. I believe it's on Thursday. Speak then. Thank you.
This does conclude today's call. Thank you for your participation. You may now disconnect.