Good day, and welcome to the Realty Income 4th Quarter and Year End 2017 Operating Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Janine Bedard, Senior Vice President. Please go ahead.
Thank you all for joining us today for Realty Income's 4th quarter 2017 operating results conference call. Discussing our results will be John Case, Chief Executive Officer Paul Muir, Chief Financial Officer and Treasurer and Sumit Roy, President and Chief Operating 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. We will disclose in greater detail the factors that may cause such differences in the company's Form 10 ks.
We will be observing a 2 question limit during the Q and A portion of the call in order to give everyone the opportunity to participate. I will now turn the call over to our CEO, John Case.
Thanks, Janine, and welcome to our call today. We're pleased to complete another successful year for our company with healthy AFFO per share growth of 6.3%. We achieved this growth while completing just over $1,500,000,000 and high quality acquisitions, generating favorable rent recapture rates and continuing to strengthen our balance sheet, becoming one of only a handful of REITs with at least 1 A credit rating. We are introducing 2018 AFFO per share guidance of $3.14 to $3.20 which represents annual growth of approximately 3% to 5%. Let me hand it over to Paul now to provide additional detail on our financial results.
Paul?
Thanks, John. I'm going to provide highlights for a few items in our financial results for the quarter year, starting with the income statement. Interest expense increased in the quarter by $12,500,000 to $61,500,000 This increase was due to the $2,000,000,000 of long term bonds we issued during 2017 as well as lower interest rate swap gain versus the comparative quarter a year ago. Our G and A as a percentage of total rental and other revenues was 5.1% for the quarter and 5% for the year, which was in line with our full year projection. We continue to have the lowest G and A ratio in the net lease REIT sector, and we project 5% in 2018.
Our non reimbursable property expenses as a percentage of total rental and other revenues was 1.8% for the quarter and 2% for the year, which also was in line with our full year projection. We expect non reimbursable property expenses to remain in that 1.5% to 2% range in 2018. Funds from operations or FFO per share was $0.61 for the quarter and $2.82 for the year. In the Q4, we recognized a one time charge of $42,400,000 or $0.15 per share as a result of the early redemption of our 6.75 percent 2019 bonds, which we replaced with longer term and lower coupon bonds. As a reminder, our reported FFO does follow the NAREIT defined FFO definition, which includes various non recurring and non cash items such as interest rate swaps, gains or losses, amortization of lease intangibles, the $0.05 charge we incurred in connection with our preferred stock redemption back in April and this $0.15 bond redemption charge we incurred in December.
These two redemption charges from liability management this year totaling $0.20 were the primary driver of the difference in FFO and AFFO in 2017. Adjusted funds from operations or AFFO or the actual cash we have available for distribution as dividends was $0.76 per share for the quarter and $3.06 for the year, representing a 6.3% increase over 2016. Briefly turning to the balance sheet. We've continued to maintain our conservative capital structure. During the quarter, we raised $136,000,000 in equity, primarily through our ATM program.
For the full year, we raised over $1,400,000,000 in equity at approximately $60 per share. Additionally, we issued $1,300,000,000 in long term fixed rate unsecured bonds during the quarter at a weighted average yield of 3.48% and a weighted average term of 11.8 years. Last year, we extended the weighted average maturity of our bonds from 6.6 years at the start of the year to 9.3 years at the end of 2017. Additionally, our fixed charge coverage ratio is now 4.8x, which is the highest coverage in our company's history. Our overall debt maturity schedule remains in very good shape with less than $100,000,000 of debt coming due the remainder of 2018, and our maturity schedule is well laddered thereafter.
Our overall leverage remains modest. Our pro form a debt to EBITDA, assuming the annualized impact of our 4th quarter acquisitions, is now 5.4x. In summary, we continue to have low leverage, excellent liquidity and strong coverage metrics. And now let me
call back over to John. Thanks, Paul. I'll begin with an overview of the portfolio, which continues to perform well. Occupancy based on the number of properties was 98.4%, an increase of 10 basis points versus the year ago period and matching our 10 year high for year end occupancy. We expect occupancy to be approximately 98% for 2018.
During the year, we released 259 properties, recapturing approximately 106% of the expiring rent, which is significantly above our long term average. This was our 6th consecutive quarter of leasing recapture rates above 100%. Our recapture rates reflect net effective rents as we saw them incur tenant improvements and leasing commissions. This compares favorably to those companies in our sector who also report this metric. Additionally, our recapture rates have continued to improve as we have increased our active asset management efforts.
Since 2013, our recapture rates have been 102%, an improvement over our previous run rate of 96%. This is a testament to the talent and experience of our portfolio and asset management teams, which we view as one of our competitive advantages in the net lease industry. Moving on to dispositions, we also continue to selectively sell properties that no longer meet our investment criteria. In 2017, we sold $166,000,000 of non strategic assets, achieving an unlevered IRR of approximately 10% and a cap rate on leased property sales of approximately 7%. 20% of the disposition proceeds were from vacant assets that we were pleased to dispose of given the associated carrying costs.
These negative cash flowing properties were sold at an attractive unlevered IRR of approximately 9%. This allowed us to recycle the proceeds into properties that better fit our investment criteria, generating earnings growth and incremental shareholder value. Our same store rental revenue increased 1% during the year, which is consistent with our projected run rate for 2018. The methodology for our same store pool excludes properties that were vacant, under development or redevelopment or involved in imminent domain actions during any point of the comparable periods. Our methodology is consistent with how we manage our portfolio, isolating our rental rate trends on leased assets.
However, we recognize that some in the investment community prefer to analyze this metric without excluding any properties. As a result, we have decided to add an additional disclosure, which we will present on an annual basis at year end to reflect our same store rental revenue growth inclusive of all properties owned for the entirety of the comparable periods. In 2017, our same store rental revenue growth for all properties owned in both comparable years was also 1% of rent. 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 year, our properties were leased to 249 commercial tenants and 47 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 about 12% of rental revenue. Walgreens remains our largest tenant at 6.5 percent of rental revenue and drugstores remain our largest industry at 10.6 percent of rental revenue. Within our retail portfolio, over 90% of our rent come 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, where the vast majority of U. S. Retailer bankruptcies in 2017 were in industries that do not possess these characteristics. We continue to have excellent credit quality in the portfolio with 46% of our annualized rental revenue generated from investment grade rated tenants. The store level performance of our retail tenants also remains sound.
The weighted average rent coverage for our retail properties is 2.8 times on a 4 wall basis, while the median remains 2.7 times. This metric is currently at the upper end of our historical range. Our watch list remains in the low 1% range as a percentage of rent, which is also consistent with our levels of the last few years. Moving on to acquisitions. We completed just over $1,500,000,000 in acquisitions in 2017, of which $563,000,000 was completed during the Q4.
We continue to see a steady flow of opportunities that meet our investment parameters. During the quarter, we sourced $6,200,000,000 in acquisition opportunities, bringing us to $30,400,000,000 sourced in 2017. We remained selective in our investment strategy, acquiring approximately 5% of the amount sourced. While our capital costs have increased recently, we continue to invest at accretive investment spreads over our short term cost of capital that are consistent with our historical average of approximately 150 basis points. As a reminder, our nominal 1st year weighted average cost of capital reflects both our current AFFO yield as well as our cost of 10 year unsecured fixed rate debt, which has experienced considerable spread compression following our upgrade to A3 by Moody's in November.
Our continued low cost of capital allows us to acquire the highest quality properties that provide favorable long term returns, while also creating meaningful near term earnings growth. Given the continued strength and our investment pipeline and the current market environment, we're estimating 2018 acquisitions to be $1,000,000,000 to $1,500,000,000 As a reminder, this estimate primarily reflects our typical flow business and does not account for any unidentified large scale transactions. I'll hand it over to Sumit now to discuss acquisitions and dispositions in more detail.
Thank you, John. During the Q4 of 2017, we invested $563,000,000 in 130 properties located in 27 states at an average initial cash cap rate of 6.25 percent and with a weighted average lease term of 13.6 years. On a revenue basis, approximately 65% of total acquisitions are from investment grade tenants. 91% of the revenues are generated from retail and 9% are from industrial assets. These assets are leased to 28 different tenants in 16 industries.
We closed 30 discrete transactions in the 4th quarter and the average investment per property was approximately $4,300,000 During 2017, we invested $1,520,000,000 in 303 properties located in 40 states at an average initial cash cap rate of 6.4% and with a weighted average lease term of 14.4 years. On a revenue basis, approximately 48% of total acquisitions are from investment grade tenants. 95% of the revenues are generated from retail and 5% are from industrial. These assets are leased to 61 different tenants in 23 industries. Of the 80 discrete transactions closed during 2017, 4 transactions were above $50,000,000 Transaction flow continues to remain healthy.
Of the opportunity sourced during the year, 49% were portfolios and 51% were 1 off assets. Investment grade opportunities represented 23% for the 4th quarter.
Of the acquisitions closed in
the 4th quarter, 57% were one off transactions. As to pricing, cap rates remained steady in the Q4. Our investment spreads relative to our weighted average cost of capital were healthy, averaging 175 basis points in the 4th quarter, which were above our historical average spreads. We define investment spreads as initial cash yield less our nominal 1st year weighted average cost of capital. Our disposition program remained active.
During the quarter, we sold 13 properties for net proceeds of $97,200,000 at a net cash cap rate of 6.9% and realized an unlevered IRR of 8.7%. This brings us to 58 properties sold during 2017 or $166,200,000 at a net cash cap rate of 7.1% and an unlevered IRR of 9.9%. We had an exceptional year in 2017 regarding acquisitions as well as dispositions. We look forward to achieving our 2018 acquisition target and disposition volume between $75,000,000 $100,000,000 With that, I'd like to hand it back to John.
Thanks, Soumit. As Paul said, 2017 was a very active year for our capital markets activities. We issued just under $1,500,000,000 in common equity at an average price to investors of $60 per share. Additionally, we issued $2,000,000,000 in fixed rate unsecured bonds at a weighted average yield of 3.7% with a term of over 14 years. The nearly $3,500,000,000 of permanent and long term capital was used to term out our line balance, fund our acquisitions activity and redeem high coupon bonds.
As a result of these capital markets activities, we reduced our leverage and extended the average term on our debt by almost 3 years. We currently have approximately $1,500,000,000 available on our $2,000,000,000 line of credit. We have ample liquidity and flexibility as we grow our company. Last month, we increased the dividend for the 95th 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 4.7%. We are proud to be one of only 5 REITs in the S and P High Yield Dividend Aristocrats Index. Our 2017 AFFO payout ratio of 82.6% was our lowest payout ratio since 2,007. To wrap it up, we are pleased with our company's performance in 2017 and remain optimistic for 2018. Our real estate portfolio, acquisitions pipeline and balance sheet all 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. The question and answer session will be conducted electronically. And we'll take our first question from Joshua Dennerlein with Bank of America Merrill Lynch.
Hey, guys. Good
afternoon. My question
is on lease renewals. What were the nature of lease renewals in 2017? Could you renew anything early that might have been expiring in 2018 or beyond? And what's up for renewal this year that you haven't renewed yet?
Yes, that's great question, Josh. We have consistently proactively got in front of our future years lease rollover. So last year, we were able to address more than 30% of the 2018 leases rolling during 2017. So we had good activity on the properties re leased in 2017, achieving above average recapture rates. We didn't really have a lot of significant releasing activity amongst our top 20 tenants, but we did have some fairly sizable portfolios that we were able to address in 2017 that were set to expire in 2018.
One of those was our P and C Bank portfolio. We owned 49 assets leased to P&C Bank and we were able to release 47 of the 49 assets to P&C during 2017 and extending the maturities from 2018 to ranging from 2023 to 2029 and we were able to add a substantial turn to those leases and also recapture rental rates that were well above our average for the year. So that's something we've always done. And as we sit here today, we're working on 2019 2020 lease rollovers, including the remaining lease rollovers for 2018.
Great. Thank you. I'll yield the floor with that
one. Thank you.
And next we'll go to Vikram Malhotra with Morgan Stanley.
Thanks for taking the question. It seems like your acquisition guidance for the year was a little bit above expectations. You've mentioned there's no unidentified portfolio in there, but is there something large that you may have identified? And just related to that, can you give us a sense of where you could take leverage if say the equity markets don't cooperate?
Sure. The acquisitions estimate we came up with for this year is the highest that we've come up with at this juncture of the year. Last year, as you may recall, at this point, we were predicting $1,000,000,000 in acquisitions and we executed dollars 1,520,000,000 in acquisitions. So we're optimistic. We're seeing good transaction flow on the acquisition side And we think the right range and the current market conditions is 1,000,000,000 to 1,500,000,000 dollars We have a number of sources of capital to fund our acquisitions growth, including we have a conservatively capitalized balance sheet today.
So we do have some debt capacity. We do have $1,500,000,000 available on the line of credit, but we also have retained cash flow proceeds and then proceeds from asset sales as well to help us fund our acquisitions growth. While we could fund growth at today's share price and have it be accretive, It's something we'd prefer not to do. I think we're one of the few REITs in the sector that actually could say that. But it would be something we'd prefer not to do at this juncture.
Okay. And then just second question, the same store NOI calculation that you provide, including all properties, just curious, have you done that calculation for say 2015 2016 just so we get a sense of how that number has trended?
Yes, we have. And it's been relatively consistent. So let me look at these. Yes, so it's in 2016, it was right at about 1%. And in 2015, it was right at about 1.8%.
So we've looked at this and it's remained pretty consistent. So I think it will continue to remain more or less in this range. And going back to your first question, I think something I failed to answer was where are we comfortable in terms of leverage. We're very much committed to our current ratings from Moody's of A3 and S and P at BBB plus with a positive outlook and Fitch at BBB plus So we want to preserve those ratings because along with those ratings comes a very attractive cost of debt capital that helps our business.
Okay. And next we'll go to Nick Joseph with Citi.
John, just going back to your comments on equity issuance. How do you think about balancing issuing equity conceivably below either consent to Sanofi or your view of where NAV is versus an attractive investment spread relative to investment opportunities?
Yes. Well, we would like to issue equity at higher prices than lower prices. Obviously, due to macroeconomic factors, the sector has been under some pressure in terms of values. But again, I'll go back to what I said a moment ago that we have multiple sources of capital to fund our growth. And while we could fund some growth accretively at these equity prices, we prefer not to issue at these equity prices.
So and don't believe we necessarily will have to do that.
Thanks. And then just maybe more broadly on the transaction market, have you seen any adjustment of cap rates or deal volume, given the rise in interest rates? And then maybe secondly, if rates just stabilize around 3%, if cap rates haven't moved already, do you think they would move, just given the kind of past movement of rates already?
Yes. So, we've always seen, over our careers and lifetimes, cap rates following the cost of capital, albeit with a lag. They're not like the 10 year treasury or securities that on a minute by minute basis have relatively significant changes in their yield. So cap rates tend to follow the cost of capital over the longer run. So it may take a quarter or 2 or even 3 for cap rates to catch up to where capital costs are.
I will say, however, that while our cap rates were pretty much unchanged in the Q4 of last year and the discussions we're having with the sellers today, there's more of a willingness to entertain negotiations and transactions at cap rates that are higher than where they would have been in 2017. So perhaps we're seeing the beginning of that movement. And we would expect to see it occur throughout the year if capital costs were to remain elevated.
And next we'll go to Karin Ford with MUFG Securities.
Hi, good morning. Just to follow-up on the capital discussion we're having here. John, just want to be clear. So do you think you have enough debt capacity, excess cash flow and or disposition proceeds that you could fully fund your acquisition guidance today with no ATM issuance?
Well, I think it all depends on the level of asset sales. The retained cash flow after CapEx is pretty fixed around $150,000,000 But on the asset sales front, that's something we could tweak. We're guiding to $75,000,000 to $100,000,000 But last year, we did almost $175,000,000 dollars So then we have some additional leverage capacity given the conservative nature of the balance sheet today. And could that get us to within the range? I think it could.
I think it could. I mean, we'll have to look at that and see. But again, we are fortunate and that at today's price, we could invest accretively at today's share price. But we would prefer not to, given the current levels. Great.
Thanks for that. My second question is just on your core expectations for 2018. No performance has been really steady, credit has been great in your portfolio up to this point. But given the continuing evolution of what's going on in your tenant base, both with consolidation, disintermediation and the like, did you consider taking a more conservative approach about your occupancy expectations, for example, maybe considering potential store closures for this year?
Well, we looked at the entire portfolio and our portfolio has been more resilient to the impact of e commerce, given its nature with having a service nondiscretionary or deep low price point orientation to it. But as we did our analysis and preparing our plan for this year, we accounted for what we believed would be tenant credit issues that would occur in 2018 and those are baked into our guidance. And at this point, we're not expecting and we're not hearing of any material tenant credit issues within the portfolio.
Okay. And next we'll go to Collin Mings with Raymond James.
Thanks. Good afternoon. First question for me, just going back to the flexibility you just highlighted on the disposition front, depending upon the capital markets. Any specific thing driving initial guidance here suggesting like a material deceleration from last year?
Well, last year was a bit of an outperformance. We were able to sell 2 office buildings accounting for about $73,000,000 in proceeds. We your office is not strategic to our investment philosophy. So we had been trimming that down and you can see that in our numbers. So it was a bit higher than normal.
But that's a program we can flex on the disposition side if we needed to. So if the capital we could access through dispositions was more appealing from a valuation and price perspective than issuing shares, we could certainly do that and increase the levels through our asset management team on the disposition side. But as of right now, we're still guiding to $75,000,000 to $100,000,000 in dispositions. As you all know, typically, we've exceeded those numbers.
Okay. And then, maybe just as far as acquisition activity during the quarter, can you maybe just industrial acquisitions during the quarter as well as the increased exposure to Walmart?
Yes. We had a high quality group of acquisitions that closed in the 4th quarter and that was reflected, I think, in the pricing. We also had a high percentage of investment grade. And in terms of the types of investments we made in the 4th quarter, we did have about 10% of the acquisitions were industrial properties and leased to existing tenants. These were relationship transactions leased to large cap investment grade rated tenants that we were very pleased to work into the portfolio.
And next we'll go to Todd Stender with Wells Fargo.
Hi, thanks. Just to stick on that Walmart theme, you guys acquired a couple Walmart Sam's Clubs. What were the lease terms? And are there any rent escalators? It's an investment grade rated tenant, but like CVS, I wondered if they're flat.
Yes. Well, on our Walmarts, we have lease escalators on about 30% of that portfolio. So the primary Walmart exposure that we picked up in the Q4 was in the neighborhood markets. And obviously there you have a 25% national market share in the neighborhood markets. And those have been operating very well and they're incorporating their e commerce strategy, omni channel platforms and associating that those initiatives with their brick and mortar buildings.
So they've been performing quite well and we're pleased with that.
And how much is left on the lease of that stuff?
I think they're somewhere around 15 to 17 years on that particular segment. Overall, the average weighted lease turn for our entire Walmart exposure is 12 years.
Okay. Thanks for that. And then just, you also acquired some Dollar Stores. Any updated thoughts there? It's long been thought of as an Internet resistant space, but then you see headlines of Amazon willing to ship dollar level items.
Any comments there?
Well, the dollar stores have just been a home run for us here over the last 6, 7 years, as you know, Todd. Dollar General has experienced 27 consecutive years of same store growth and then Dollar Tree and Family Dollar have experienced non consecutive years of same store growth. So they continue to do quite well despite any Internet pressures. They're largely insulated from Internet pressures because their customers use cash. Often they're in small towns or rural areas.
Their customers are less likely to shop online. The average basket size is $10 to $15 and they're typically buying products that are immediately needed, maybe a quart of milk or butter or some produce for dinner that night. So and given the challenges of a large national player trying to efficiently and cost effectively deliver in some of these more rural and smaller locations. At this juncture, we're just not seeing any impact from e commerce on their businesses. So we're pleased with making some additional investments there.
I don't think we'll raise our exposure overall to that industry on a relative basis in a material way, but it might creep up a little bit because it's performed so well for us.
And next we'll go to John Massocca with Ladenburg Thalmann. Good afternoon.
Hey, John.
So, I think you kind of talked about it with regards to Walmart, but what percentage of your portfolio today has no rent escalators and what percent has escalators based on CPI?
Yes. So, I'd say 88%, 89% have rent escalators and CPI escalators are somewhere around, Paul, 15%. That's
15% of the leases.
About 15% of the leases.
Okay. That makes sense. And then with regards to the Albertsons Rite Aid merger, how do you think that affects the 10th credit there? Any thoughts that that might
be an opportunity for additional acquisitions?
Yes. Well, I think we really don't have any exposure, any material exposure to Albertsons. But as you know, Rite Aid has been in our top 20 for a while now. Rite Aid is selling properties to Walgreens and we've seen 7 of our Rite Aid's go to Walgreens and would expect another 7 to 10 more going to Walgreens. But we view the announcement, those plans and discussions positively.
It's going to create cost savings and synergies throughout the business. Rite Aid will be able to Albertsons owns and accessing their customers. And Albertsons owns and accessing their customers and making it more competitive with the PBM businesses of companies such as CVS. So in addition, Rite Aid will be able to improve their food service offerings and having access to the private label prepared foods that Albertsons has been very successful at selling. So it really just gives some size, scale, significant synergies to compete better against existing peers in their sector and also potential new entrants.
And we're seeing a lot of consolidation, both horizontal and vertical consolidation within the drugstore industry. And we think that that makes that industry a stronger industry as it creates more efficient companies and gives drugstore players like Walgreens and CVS and Rite Aid, additional captive customers. So that's the key. So we view that quite positively.
This concludes the question and answer portion of Realty Income's conference call. I would now like to turn the call over to John Case for concluding remarks.
Okay. Well, thanks, David, and we appreciate everyone for joining us today. Look forward to seeing everyone over the next few weeks at various conferences. And thank you for participating in the call and have a good afternoon.
And that does conclude today's conference. We thank you for your participation. You may now disconnect.