Good day, 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 Janine Bedard. Please go ahead.
Thank you all for joining us today for Realty Income 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, Janine. Welcome to our call today. I'm honored to have taken on the role as CEO, and I'm 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'm 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-minus 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- $3.21 to a range of $3.18 $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 at 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 a service, non-discretionary, and/or low price point component to their business. We believe these characteristics allow our tenants to compete more effectively with e-commerce and operate in a variety of economic environments.
These factors have been particularly relevant in today's retail climate, with a 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 2.9 times on a four-wall basis, while the median is 2.7 times. 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 re-leased 64 properties, recapturing approximately 108% of the expiring rent. Year-to-date, we have re-leased 166 properties, recapturing approximately 106% of the expiring rent.
Since our listing in 1994, we have re-leased or sold over 2,800 properties with leases expiring, recapturing 100% of rent on those properties that were re-leased. 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 leases 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%-2% range. Funds from operations or FFO per share was $0.81 for the quarter. As a reminder, our 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 S&P upgrade to A-minus 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 two A 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 remains 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 million of debt coming due the remainder of this year, and only $91 million coming due next year. 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-$3 billion, plus a $1 billion accordion expansion feature. The initial maturity date is March 2023, plus two six-month extension options thereafter. The increased line capacity enhances our liquidity and provides 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 five and a half 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 welcome the lenders who are new to the relationship with Realty Income. 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, five 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've 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%-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 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 remain 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're decreasing our disposition guidance for 2018 from approximately $200 million to approximately $150 million. In September, we increased the dividend for the 98th time in our company's history. Our current annualized dividend represents a 4% increase over the year-ago period. We have increased our dividend every year since the company's 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 a favorable risk-adjusted earnings growth for our shareholders. At this time, I'd like to open it up for questions. Operator?
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We ask that you please limit yourself to two questions. Once again, that is star one to ask a question, and we'll pause for just a moment to allow everyone an opportunity to signal. We'll go first to Christy McElroy with Citi.
Good morning. This is Katie McConnell on with Christy. Wondering if you could provide some color on any additional acquisitions in process or under contract currently, just to get a better sense for timing in the end of the year. Based on opportunities you're seeing in the market today, would you expect a similar pace of acquisitions in 2019?
As we've always indicated, acquisitions are very difficult to forecast a 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, at this point, to talk about what we are planning on doing in 2019 will be premature.
Okay, great. 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? What should we expect as far as pricing for remaining asset sales in the balance of the year?
No, 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, that was largely being driven by timing and some opportunistic sales that we pulled from the market. We feel like our IRRs 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.
Next, we'll go to Karin Ford with MUFG Securities.
Oh, 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's strategy. Can you elaborate what that evolution might entail? Could we 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, Karen. What I would want to emphasize is that we'll continue to execute on our current strategy as we believe the market remains very strong for the product that we are pursuing. 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.
To look at new avenues of growth is something that we are constantly doing, and we'll continue to do so. 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 success this year with corporate sale leasebacks. Do you think that could continue into next year, or do you expect that 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. Our take on our pipeline for 2019, the current discussions that we are having with our existing relationships and some new relationships, lead us to believe that the lease changes will have no impact, and the viable market for sale-leaseback will continue to grow.
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 to capital, maybe a year, two years ago, you chose to buy higher quality, did a lot of drugstores, took that exposure in certain areas up. 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 lower cost of capital that was afforded to us was a function of the strategy that we had implemented. What we had highlighted to the market as the types of retail products and industrial products that we were most interested in. 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. 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. 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 our knitting. 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. We're going to continue to do that. 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.
Just second question, I know we've talked over the last couple of weeks on this, I think everyone's just trying to get a better sense of how this change occurred, how it was thought about. It seemed a bit sudden in terms of John's departure. I'm just wondering if you can give us some sense of how this was being contemplated, any 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?
To answer the question around the suddenness, this was a decision that the board and John mutually agreed upon. These are discussions that oftentimes happen. When you think about is there a good time for a change in CEO, there never really is. The board and John mutually agreed to part ways. The board believed that making the transition now is in the best interest of the company and its shareholders. Given the depth and strength of our management team, it was believed that doing it now versus down the road was the right decision. The speed question that you raised, Vikram, I'd say there are two schools of thought on that. One, which is the more traditional route, where you had typically have a three to six-month transition period.
That works in a situation where the incoming CEO may not be immediately ready to take on the reins. 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. 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. 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.
There's a sense of continuity that we continue to have, that is going to bode well. 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. It's business as usual. 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. 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 the EVPs in the company, is going to just have one degree of separation. Those are very minor changes, but that's more in line with how I would like to run the company.
In terms of strategy, et cetera, it's business as usual.
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-Elevens acquired in the quarter, were these sale leasebacks? Can you describe the lease terms, if there's a 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- 50 basis points higher than what you would get in the one-off market. They are 16-year average lease terms, and they have 7.5% growth every five.
Okay. Thank you. Then Paul, just looking at the balance sheet. Your line balance was getting up close to $800 million just at the end of Q2, that was on the $2 billion line, and that used to be a big number, relative to the size of the company, maybe not so. 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. How big could the line balance for you guys get?
I think that's fair to consider from an overall risk management standpoint and variable rate debt exposure, either 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 felt 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 so ago, which immediately was applied to that line. That was a funded term loan. In addition, we have some property sales activity in the fourth quarter. From a funding standpoint, the line balance will not be very large.
It's currently, as of a week ago, was under $600 million after that term loan repayment. 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. 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. We're not in a position right now where we have any immediate funding needs.
We'll go next to Collin Mings with Raymond James.
Thanks, and congratulations, Sumit.
Thanks, Collin.
First question from me, going back to Karen's question, actually. As your platform continues to grow, maybe how are you currently thinking about international opportunities, specifically?
We don't have immediate plans to go international. Like I've said, all avenues are on the table, and we continue to look at avenues of growth, of which to ignore international wouldn't be correct. We don't have any immediate plans to go international. 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'll have time to test it, make sure that this is something that fits our overall strategy of conservatism and risk-adjusted growth rates. At the appropriate time, we'll be ready to speak with the market about it. No immediate plans.
Okay. 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 deal, I think you suggested maybe 75, 50 basis points. Maybe thinking of a little bit broader picture here, how are you thinking about the portfolio premium or discount in the marketplace right now? 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. What we are 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. That accrues to our favor. The fact that we've been able to do north of $1 billion of 7-Elevens 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. We feel like that there are discounts that we get by entering into these portfolio transactions, especially with sophisticated institutional tenants.
We'll go next to John Massocca with Ladenburg Thalmann.
Good afternoon, and first off, congratulations, Sumit, on the new role.
Thank you, John.
Were there any other tenant industries that particularly dominated this quarter's acquisition activity? I know with the 7-Elevens, 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.
I risk using my second question here. Was those casual dining or QSR?
Casual dining.
Okay. Does the current strategy leave open the potential for M&A activity, especially given the strong cost of capital? Are you really still primarily focused on what you've done the last couple of quarters in terms of larger sale-leaseback transactions, given how strong that market has been for you guys?
Yeah, 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. 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. John, if you're asking if this is something that we are aggressively going to start pursuing, then the answer is no. We're not averse to M&A either.
Color is very helpful. Thank you very much.
Next, we'll go to Christy McElroy with Citi.
Hey, it's Michael Bilerman here with Christy. I just had a question just regarding the CEO transition. 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 the agreements that were in place as well as his employment agreement. The approximately $28 million that we have listed was pretty much in line with his employment agreement and the agreements around his stock awards.
Right. No, if you read the proxy, it was generally in line with that. We're sitting here in November. From a timing perspective, why would he agree to forgo $10 million of a bonus if he worked basically into January 1 of next year? I don't know many people that would give up $10 million, whether he could've rolled into next year and then decided to do it.
No, I think we've also highlighted the fact that $9 million of it had already been accrued. You can pretty much assume that what had been accrued for this year was part of the $28 million that was paid out. I don't believe it's accurate for you to assume that his pro-rata share, he had to forgo that.
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.