And welcome to the Realty Income Second Quarter Operating Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Janine Bedard, Vice President. Please go ahead. Thank you and thank you all for joining us today for Realty Income's Q2 2015 operating results conference call.
Discussing our results will be John Case, Chief Executive Officer Paul Muir, Chief Financial Officer and Treasurer and Sumit Roy, Chief Operating Officer and Chief Investment 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 Q. I will now turn the call over to our CEO, John Case.
Thanks, Janine, and welcome to our call today. We've had a very active Q2 and we are pleased to report excellent results from an acquisitions, capital markets and occupancy standpoint. Additionally, we were gratified to be added to the S and P 500 index in the Q2. Our AFFO per share growth was 6.3% and a record quarterly amount of $0.68 As announced in yesterday's press release, we are increasing our FFO and AFFO per share guidance for 2015 given the company's positive year to date performance and the continued scalability of our business. We believe we are the most efficiently run net lease company with the highest EBITDA margin in the sector today.
We are raising our 2015 FFO per share guidance to $2.72
to $2.77 from $2.67 to $2.72
We are raising and tightening the range of our AFFO per share guidance to 2.69 dollars to $2.73
from $2.66 to $2.71
as we continue to anticipate another solid year of earnings growth. Now, I'll hand it over to Paul to provide additional detail on our financial results.
Thanks, John. As usual, I will provide some brief highlights of our financial results for the quarter starting with the income statement. Total revenue increased 11.1 percent for the quarter. This increase reflects our growth primarily from new acquisitions over the past year as well as healthy same store rent growth. Our annualized rental revenue at June 30 was approximately $983,000,000 On the expense side, interest expense increased in the quarter to $58,700,000 This increase was primarily due to our 2 bond offerings last year, the $350,000,000 10 year notes issued in June and the $250,000,000 12 year notes issued in September.
We also recognized a non cash loss of approximately $900,000 on interest rate swaps during the quarter. On a related note, our coverage ratios both remain strong with interest coverage at 4.0 times and fixed charge coverage at 3.6 times. General and administrative or G and A expenses were approximately $12,600,000 for the quarter. Included in G and A expense is Year to date, our G and A as a percentage of total rental and other revenues is only 5.3%. Our projection for G and A expenses in 2015 is now approximately $52,000,000 down from our prior estimate of $55,000,000 as we realize lower than expected expense growth given the efficiencies of our business.
Property expenses, which were not reimbursed by tenants, totaled $3,300,000 for the quarter and our current projection for property expenses that we will be responsible for in 2015 remains unchanged at approximately $20,000,000 Provisions for impairment of approximately $3,200,000 during the quarter includes impairments we recorded on 3 properties classified as held for sale and 2 properties classified as held for investment. Gain on sales were approximately $3,700,000 in the quarter. And just a reminder, we do not include property sales gains in our FFO or AFFO. Funds from operations or FFO per share was $0.69 for the quarter, a 7.8% increase versus a year ago. Adjusted funds from operations or AFFO or the actual cash we have available for distribution as dividends was $0.68 per share for the quarter, a 6.3% increase versus a year ago.
Dividends paid increased 4% in the 2nd quarter and we again increased our cash monthly dividend this quarter. Our monthly dividend now equates to a current annualized amount of $2.28 per share. Now let me briefly turn to the balance sheet. We have continued to maintain our conservative capital structure. As you know in early April, we raised approximately $276,000,000 of new equity capital in conjunction with our addition to the S and P 500 index.
The index inclusion was an excellent opportunity to raise capital at a very low cost by offering shares to the index funds needing to buy our stock that day. We raised an additional $106,000,000 of equity capital during the quarter through our direct stock purchase plan. Our bonds which are all unsecured and fixed rate and continue to be rated BAA1BBB plus at a weighted average maturity of 6.7 years. At the end of the quarter, we recast and expanded our unsecured acquisition credit facility from $1,500,000,000 to $2,250,000,000 comprised of a $2,000,000,000 revolving credit facility and a $250,000,000 term loan, which is due in 2020 when we have no scheduled unsecured debt maturities. At our current BBB plus Baa1 credit rating, the borrowing rate on the revolver is LIBOR plus 90 basis points with a facility commitment fee of 15 basis points, which overall represents a 20 basis point reduction to the all in drawn borrowing rate of the previous facility.
We very much appreciate the capital commitments from the 21 banks who participated in the syndication of this larger facility for us. Our new $2,000,000,000 credit facility had a $430,000,000 balance at June 30. We did not assume any mortgages during the quarter. We did pay off some at maturity to our outstanding net mortgage debt at quarter end decreased to approximately $757,000,000 Not including our credit facility, the only variable rate debt exposure we have is on just $15,500,000 of mortgage debt. And our overall debt maturity schedule remains in very good shape with only $40,000,000 of mortgages and $150,000,000 of bonds coming due in 2015 and our maturity schedule is well laddered thereafter.
Currently, our debt to total market capitalization is approximately 32% and our preferred stock outstanding is only 2.5% of our capital structure. And our debt to EBITDA at quarter end was approximately 5.9 times. Now let me turn the call back over
to John who will give
you more background on the quarter.
Thanks, Paul. I'll begin with an overview of the portfolio which continues to perform well. Occupancy based on the number of properties was 98.2%, a 20 basis points improvement from last quarter. At the end of the quarter, we had 81 properties available for lease out of 4,452 properties in our portfolio. Economic occupancy was 99.2% and occupancy based on square footage was 98.8%, both up 10 basis points from last quarter.
We continue to see good leasing activity and expect our occupancy to remain around current levels through the end of the year. We had leases expire on 80 properties during the quarter and we re leased 81 properties. 73 of those properties were re leased to existing tenants and 8 were re leased to new tenants, recapturing 106 percent of expiring rents. This compares favorably to our historical recapture rate of approximately 98% of expiring rents. Additionally, 4 vacant properties were sold during the quarter.
Our same store rent increased 1.5% during the quarter and 1.4% year to date. The industry is contributing most to our quarterly same store rent growth for health and fitness and motor vehicle dealerships. We expect same store rent growth to remain about 1.4% for the foreseeable future. 90% of our leases have contractual rent increases. So we remain pleased with the growth we were able to achieve from our properties leased to both our investment grade and non investment grade tenants.
Approximately 75% of our investment grade leases have rental rate growth that averages about 1.3%. Our portfolio continues to be diversified by tenant, industry, geography and to a certain extent property type. At the end of the second quarter, our properties were leased to 235 commercial tenants in 47 different industries located in 49 states in Puerto Rico. Our diversification contributes to the stability of our cash flow. 79% of our rental revenue is from our traditional retail properties.
The largest component outside of retail is industrial properties at 13%. This quarter, we reclassified 14 assets previously classified as manufacturing properties, representing approximately 2% of rent to our industrial category, which better reflects these properties uses and better clarifies our portfolio composition. We continue to focus on retail properties leased to tenants with a service non discretionary and or low price point component to their business. Today, more than 90% of our retail revenue comes from businesses with these characteristics, which better positions them to successfully operate in a variety of economic environments and to compete with e commerce. At the end of the second quarter, our top 20 tenants continue to capture nearly every tenant representing more than 1% of our rental revenue.
Our largest tenant is Walgreens, which now accounts for 7.1 percent of rental revenue, the increase from 5.5% at the end of the last quarter. We continue to like Walgreens business, their high quality real estate locations and the rent growth we receive. We also are confident in the strength of these properties given the visibility we have into their unit level performance. FedEx remains our 2nd largest tenant at 4.9% of rental revenue. This quarter we added a new name to our top 20 tenants.
Lifetime Fitness is now our 13th largest tenant representing 2% of rent. During the Q2, we executed a sale leaseback transaction with Lifetime Fitness. Lifetime Fitness is a tenant we have been meeting with and pursuing for about 10 years now. We follow them through challenging favorable economic conditions and have been impressed with the performance of their business. We also believe their well located real estate and excellent surrounding demographics and the service orientation of their business make them a great addition to our portfolio.
Drugstores remain our largest industry at 10.7% of rental revenue, an increase from 9.6% at the end of the Q1. The drugstore industry continues to be an area we favor given the aging of our population and today's health care trends. The convenience store industry is our 2nd largest at 9.4% of rental revenue. Dollar stores are at 9.1%, down 20 basis points from last quarter. As many of you may know, Dollar Tree completed its acquisition of Family Dollar this month, subsequent to our 2nd quarter end.
As part of the transaction, the FTC identified 330 of the combined 14,000 stores for the divestiture. There was no financial impact on our rental revenue as a result of these divestitures. Pro form a Dollar Tree will represent 4.3 percent of rental revenue. Health and fitness is our 4th largest industry at 7.2 percent of rental revenue, a 40 basis points increase from last quarter. Health and fitness is a sector we have been invested in since 1998 and it has performed very well for us.
We continue to like health and fitness given the favorable demographics supporting this industry. We continue to have excellent credit quality in the portfolio with 48% of our rental revenue generated from investment grade rated tenants. The store level performance of our retail tenants remains sound. Our weighted average rent coverage ratio for the retail properties is 2.6 times on a 4 wall basis and importantly the median is also 2.6 times. Moving on to acquisitions.
We had a very active second quarter investing $721,000,000 at an initial cash cap rate of 6.3% and initial average lease term of over 18 years. This is the 2nd highest quarterly volume of property level acquisitions in the company's history. Our straight line cap rate during the quarter was 7%, which reflects the attractive rent growth of the acquisition. For the first half of the year, we completed $931,000,000 in acquisitions at an initial cash cap rate of 6.4% and an initial average lease term of nearly 18 years. Cap rates remain aggressive, but stable.
However, our investment spreads continue to be favorable and remain above their historical norms. We continue to see a high volume of acquisition opportunities. During the quarter, we sourced about $10,500,000,000 in acquisition opportunities, which brings us to $20,000,000,000 in sourced opportunities for the year. Given our acquisitions activity to date and the high volume of opportunities we continue to see, we are increasing our acquisitions guidance for 2015 to approximately $1,250,000,000 from our previous estimate of $1,000,000,000 We continue to selectively sell non strategic assets and redeploy that capital into properties that better fit our investment strategy. During the first half of the year, we sold 14 properties for $30,500,000 We sold our leased non strategic assets at a cap rate of 7.8%.
We continue to expect a minimum of $50,000,000 in dispositions for 2015 and that figure could go up a bit. Now I'll hand it over to Sunit to discuss our acquisitions and dispositions in more detail.
Thank you, John. During the Q2 of 2015, we invested $721,000,000 in 100 properties located in 33 states at an average initial cash cap rate of 6.3 percent and with a weighted average lease term of 18.2 years. We define cash cap rates as contractual cash net operating income for the 1st 12 months following the acquisition date divided by the total cost of the property, including all expenses borne by Realty Income. On a revenue basis, 49% of total acquisitions are from investment grade tenants and the rest of the revenues are from retail tenants that are non investment grade or not rated. 98% of the revenues are generated from retail and 2% are from industrial.
These assets are leased to 21 different tenants in 13 industries. Some of the most significant industries represented are health and fitness, drug stores and home improvement. Of the 16 independent transactions closed in the Q2, 2 transactions were above 50,000,000 dollars Year to date Q2 2015, we invested $931,000,000 in 166 properties located in 35 states at an average initial cash cap rate of 6.4% and with a weighted average lease term of 17.5 years. On a revenue basis, 52% of total acquisitions are from investment grade tenants and the rest of the revenues are from retail tenants that are non investment grade or not rated. 92% of the revenues are generated from retail and 8% are from industrial.
These assets are leased to 27 different tenants in 16 industries. Some of the most significant industries represented are health and fitness, drug stores and quick service restaurants. Of the 25 independent transactions closed year to date, 3 transactions were above 50,000,000 dollars Transaction flow continues to remain healthy. We sourced more than $10,000,000,000 in the 2nd quarter. Year to date, we have sourced approximately $20,000,000,000 in potential transaction opportunities.
Of these opportunities, 66% of the volume sourced were portfolios and 34% or approximately $7,000,000,000 were one off assets. Investment grade opportunities represented 21% for the year to date. Of the $721,000,000 in acquisitions closed in the Q2, approximately 5% were one off transactions. We remain selective and disciplined in our investment approach closing on less than 7% of deals sourced and continue to capitalize on our extensive industry relationships. As to pricing, cap rates continue to remain tight in the 2nd quarter with investment properties trading from around 5% to high 6% cap rate range and non investment grade properties trading from high 5% to low 8% cap rate range.
As John highlighted, our disposition program remained active. During the quarter, we sold 5 properties for $8,000,000 at a net cash cap rate of 8.1 percent and realized an unlevered IRR of 11.6%. This brings us to 14 properties sold year to date for $30,100,000 at a net cash cap rate of 7.8% and realized an unlevered IRR of 12.3%. Our investment spreads relative to our weighted average cost of capital were healthy averaging 140 basis points in the 2nd quarter, which were around our historical average spreads. We define investment spreads as initial cash yield less our nominal 1st year weighted average cost of capital.
Year to date, based on the weighted average cost of long term capital raised, our estimated investment spreads were approximately 200 basis points, notably above our historical average. In conclusion, the 2nd quarter investments remained solid at $721,000,000 while sourcing more than $10,000,000,000 in transactions. Our year to date spreads remained above historical levels. We continue to be very selective in pursuing opportunities that are in line with our long term strategic objectives and within our acquisition parameters. We are also taking advantage of an aggressive pricing environment to dispose assets that are no longer a strategic fit.
As John mentioned, we are raising our acquisition guidance for 2015 to approximately $1,250,000,000 With that, I'd like to hand it back to John.
Thanks Sumit. We're pleased to have taken advantage of the capital market conditions during the first half of the year to satisfy the majority of our capital needs for our acquisitions year to date, raising $484,000,000 in equity capital at an average per share price of approximately $50 and issuing a $250,000,000 unsecured term loan at 2.7%. Additionally, our new $2,000,000,000 revolving credit facility was recast at a lower rate than our previous revolver and provides for additional financial flexibility as we continue to grow our company. Our sector leading cost of capital continues to allow us to drive earnings growth while investing in high quality assets. We increased the dividends paid this quarter by 4% on a year over year basis.
We have increased our dividend every year since the company's listing in 1994, growing the dividend at a compound average annual rate of almost 5%. Our payout ratio in the 2nd quarter was 83 point 7%, which is a level we continue to be comfortable with. Finally to wrap it up, we continue to maintain excellent momentum in our business. We continue to have very active dialogues regarding potential acquisition opportunities with existing and prospective tenants. We remain well positioned to execute on acquisitions with approximately 1,600,000,000 dollars available on our new $2,000,000,000 revolving line of credit.
At this time, I'd like to open it up for questions. Operator?
We'll take our first question from Juan Sanvira with Bank of America Merrill Lynch.
Hi, thanks. This is actually Josh Turner on line with Juan Sanabria. Two questions for you guys. First, can you talk about the specific cap rates, rent coverages and annual rent bumps for the Walgreens and Lifetime Fitness Portfolios?
No. We're not allowed to talk about the specifics of the Walgreens transaction based on the non disclosure agreement we've executed with them.
Okay. How about Lifetime Fitness? Any Could you maybe talk about how you thought about alternative values and residual value for the assets?
Yes. I can walk you through Lifetime Bed Fence. Obviously, it's an industry we like. We've been in that industry since 1998. There continues to be a secular shift to healthy lifestyles and we're seeing that in the health and fitness facilities.
We see that with both baby boomers and the millennials. And Health Club usage continues to rise. We saw attractive risk adjusted returns in this investment. It was well structured with a strong cash flow coverage of 3.2 times and a drop in sales to breakeven on our properties of 45%. If you look at the last recession, the great recession, lifetime same store revenues fell by just under 3% in 2,008 and about 7% in 2,009 and then turned positive in subsequent years.
So they performed quite well during some very challenging times. The properties that we own are located in affluent dense markets with high average household incomes of $74,000 within a 5 mile radius and densely populated areas with 217,000 people within a 5 mile radius of our properties. We were able to execute this transaction at about a 20% discount to replacement costs and have a portfolio of properties that are well above the average sales and EBITDAR levels of the overall club. So we were quite pleased with it. The going in cap rate was 6.5%.
The straight line cap rate, which would reflect the growth and the cash the cash growth in the lease over the lease term was about 8%. So we were pleased with the growth. As we look at the transaction, we really viewed it more as something I mean, we asked for 10 years of financial and operating history and our credit and research team analyzed that quite thoroughly. And we were convinced that these would continue to be operated as health and fitness clubs. If there had to be a residual use, the most likely residual use would be office, if they could not be used as health clubs.
But there are other companies that have operated large health clubs of this size including ClubCorp, Equinox and Bay Club. So they could be potential tenants as well. So if you were to convert these to office, you're probably looking at something from $50 to $75 a foot to make these office properties. But that's not really how we looked at it.
Thank you very much. I'll yield the floor on that.
We'll go next to Nick Joseph with Citigroup.
Thanks. Curious what the impact is of interest rate volatility in terms of your conversations with potential sellers?
Well, it comes up some. There's been a fair amount of it and it comes up in discussions where we're talking about pricing. And it's something certainly that when there's a downswing, sellers are trying to put pressure on us. And when there's an upswing in the 10 year treasury rate, we're certainly pushing for more yield with regard to our initial cap rates and our overall cap rates.
Have you historically seen a correlation between increased volatility and less acquisition volume? Or do you think it's more just on the pricing?
No. I mean, we've been in an environment that's been volatile with regard to interest rates as you've seen and we've sourced year to date $20,000,000,000 in acquisition opportunities, which puts us on a pace that would break our all time high in terms of source acquisition opportunities.
Thanks. And then can you talk about the decision to issue the 5 year debt versus doing a longer dated maturity?
Yes, sure. We did issue the $250,000,000 5 year unsecured note with our bank group. And it was really done for several reasons. One is we did have a window in our maturity schedule at 5 years. And one of the issues with the banks has been that we had typically not kept a lot of outstandings on our revolver.
And they were looking for more funded balances. So when we had 21 banks step up and commit to a recast new expanded facility of 2,000,000,000 dollars We wanted to make sure we were meeting some of their demands and some of their desires as well. And something they asked for was a concurrent term loan with the revolver. And they were much more comfortable and desirable in a 5 year term than a 10 year term where we also have a window in our maturities. So that drove it and very attractive pricing.
Pricing well inside of where we could have gotten a 5 year unsecured note issued in the unsecured debt market.
Thanks. And then I guess with over $400,000,000 on the credit facility and then $150,000,000 coming due later in this year, should we expect a 10 year offering later?
We're going to look at our capital options as the markets evolve over the remainder of the year and determine how we want to fund the business based on what the market show us. So it could range from all types of capital from 10 year or longer to equity as well.
Thanks.
Thank you.
We'll go next to Vikram Malhotra with Morgan Stanley.
Thank you. Just to clarify on Lifetime, can you maybe I guess you looked at some of the other tranches of our with tranches within Lifetime that were being marketed. What were maybe some of the differences? It sounds like maybe the term or the rent pumps were different from something that one of your peers took or bought?
I mean, the portfolios are all very similar. We were obviously pleased with the portfolio we received and we were able to work with Lifetime in structuring that portfolio and it met our demands and it also met the desires of the Lifetime team.
But your rent bumps were higher or your term was different from the other portfolios?
Our lease term was 25 years, which I think is different than the lease term on some of the other portfolios, I believe. Okay.
And then as you look at these couple of portfolios you've done and is there are they under a master lease? And can you do you have the ability to if you choose to maybe sell a few of the assets?
Yes. They're under a master lease, but we have no intention of selling the assets that are in our portfolio.
Okay. And then just maybe last one as you look forward, if you look at your guidance, obviously, it bakes in about $150,000,000 a quarter, which is a bit lower. But I'm assuming that's just kind of the baseline acquisitions, the relationship driven ones. And so over and above that there could be other portfolios that you may close?
Yes. The acquisitions guidance we provided for the year assumes our one off transactions as well as our smaller portfolio transactions and we did not factor in any large sale leaseback or very large portfolio transactions.
And just what cap rate are you assuming for the back half of the year?
As we look forward, we think cap rates will be in the mid to high 6s for the type of properties we buy.
Okay. Thank you. Thank you.
We'll go next to Tyler Grant with Green Street Advisors.
Yes. Thank you. You guys have done a good job raising the bar for the net lease sector on real estate related disclosure. With that said, it seems that a good next progression should be to improve disclosure related to the quality of the lease contracts. So for example, the percentage of tenants that report unit level financials, investment amounts relative to replacement costs or the proportion of assets that are not operating, but are paying rent.
Can you provide some numbers for these data points now and maybe for similar data points that you believe are worth mentioning? And then also going forward, what's the feasibility of providing this type of data systematically within your quarterly financials?
Yes. I mean, we'll continue as we've done this quarter to add data to our supplemental investor package, which we agree with you is the most robust in the industry. A lot of our competitors are not providing anywhere near the level of information we are. So we certainly have issues with some of the information that present competitive issues for us to consider. So we're going to see where the industry evolves, Tyler, and continue to add and tweak our supplemental package.
But in terms of just a full dump of everything, we're not anticipating doing that for competitive reasons at this point.
And I guess if I look at it, even if
we got aggregate numbers, so for example, the coverage ratio of 2.6 that you guys disclosed, what percentage of your retailers are actually providing you with financials so that you can arrive at that figure?
Yes. So just under 70% of our retail tenants provide us with sales and profit and loss information. So that should give you an idea of what that number is.
All right. Great. That's all for me.
Okay. Thanks, Tyler.
We'll go next to Dan Donlin with Ladenburg Thalmann.
Thank you and good afternoon. John or Sumit, I was just curious the releasing spread of 107 was up nicely versus the Q1 and seems to be quite higher than I would have expected given kind of the nature of your business. Can you maybe talk about why the leasing spread was so positive? Was it any one tenant or any detail would be helpful? Yes.
I mean the primary reason why is we were able to retain 90% of our existing tenants this quarter. And those tenants typically have options to renew and those options have a fairly significant cost to them. So they exercise the options to renew and that resulted in the high rent relative to the expiring rent.
Okay. And then just
go ahead.
Yes. And I was going to ask another question. The as far as your tenants that are not rated, could you maybe give us a percentage of those tenants that are not rated because they don't have any debt? In other words, they would be investment grade, but they just don't have any debt? Or do you have any metrics on that?
Well, we do. I don't have them off the top of my head. There are number of tenants you're talking about the 52% non investment grade rated tenants? Right. I would say that we can get that figure, but we don't have it right now.
I mean, some are rated and are below investment grade and some are simply not rated and have excellent balance sheets that are just not rated.
Okay. And then I guess a question for Paul. The $20,000,000 of unreimbursed property expenses seems fairly high given that you've only recognized I think $7,300,000 year to date. So just kind of curious is there some type of seasonality in this number? Or are you just being conservative?
Or is there some type of one time items you're expecting?
Yes. That's good observation. So property expenses have come in a little bit lower, lower maintenance utilities, bad debt expense lower kind of across the board. There is a little bit of seasonality. Typically the second half of the year property unreimbursed property expenses are higher.
But to be candid that $20,000,000 is a number we're monitoring. And we suspect that that could be a high estimate we shall see as the year progresses. But the second half of the year typically is a little bit higher.
Okay. Appreciate that. And then just on the G and A coming down $3,000,000 you briefly touched on it, but we're just kind of curious if you could give us a little bit more detail. I mean, did you just not need to hire as many people? Or kind of what was more detail would be helpful?
Yes, I can provide that. We did realize some specific cost savings that we had not anticipated in October when we originally
really in our legal area with insurance.
And those were really in our legal area with insurance and with our annual report and the way we handled that this year. And those on a combined basis were 7 figure number with regard to savings. We also saw that we were more appropriately staffed for our activity than we had expected to be last October. Over the last 4 years, we've increased our headcount here by 50% and we've added a lot of skilled excellent staff members, team members who've done a great job. So we're really beginning to realize the efficiencies and the scalability of our business.
And this was a conscious decision we made several years ago to build the team, anticipating the growth in the sector and certainly our continued growth. So that's what you're seeing in that G and A line and we're certainly pleased to see it. And I would expect our G and A margins to continue to be at this level or even continue to decline.
Okay. Appreciate it. And then just last one for Paul or John. Just kind of curious on the decision to swap out the term note. You really don't have a lot of floating rate debt and I can understand being conservative, but why not just have a little more floating rate debt at this point in time?
What's the thought process there?
We looked at that. In fact, when we were making that decision, we took a look at our peer group inclusive of not only the net lease sector, but our S and P 500 peers and what our floating rate debt exposure looks like in our balance sheet. We compare very favorably. Even if we had not swapped out that term loan, we would still be very much on the low end of that spectrum in terms of exposure to variable rate and floating rate debt in our balance sheet. But ultimately, we came to the decision that we wanted to continue to handle the balance sheet as we have historically, which is to lock in longer term generally unsecured fixed rate alternatives there that match fund our acquisitions and not be exposed to any rising interest rates going forward and the volatility that that's associated with.
So right now other than our credit facility, the only exposure we have to variable rate debt is the $15,500,000 of mortgage debt exposure.
Okay. Thank you. That's it for me.
We'll go next to Todd Lueckasek with Morningstar Capital.
Hey, good afternoon, guys. Thanks for taking my questions. Just one on the same store rents. I noticed motor vehicle dealerships were a large contributor up 17% in the quarter. Can you just explain how you got such a big jump?
Is that just big re leasing spreads upon expiration and renewal? Or is something else going on there?
Really, it was a function of percentage rents that drove that. Street and Rose which is our largest motor vehicle dealership Kennett had a particularly strong first half of the year. And as we've seen the economy recover, we've seen RV sales grow quite a bit. And as a result, they tripled some percentage rents, which help drive that number.
Is that something that resets the base rents higher than or is that potentially a headwind at some point in future quarters?
No, it doesn't reset the base rent.
Okay. And then I think historically you guys have had a bit more preferred equity in the capital structure. I was just wondering if you could go through your thought process on that. Is it likely to increase again on a go forward basis? Or is preferred just too expensive at this point relative to other funding sources?
Right now, it's not priced appropriately. It's something we always look at and we do have about 2% out there in preferred right now. But it's more efficient and effective for us to use alternative forms of capital given where that market is right now. There's certainly windows in that market where it's attractive and we'll consider reissuing. But currently that opportunity does not exist.
Okay. And then just one last one for me. Can you comment on what percentage of the transactions that you evaluate and maybe also the percentage of transactions that you close if the number is different that are off market as opposed to being marketed to a number of potential buyers? Or is everything just so competitive that it's all on market stuff?
Well, I mean most of what we did this year has been relationship oriented. It's over 90%. But that doesn't mean we were the only firm to look at the acquisition. That could mean it was a strictly negotiated transaction with the tenant or seller, which some have been. But it also could mean that they accepted our price at a lower price in order to do business with us given the strength of our relationship or they gave us a last look at the pricing on the transaction and an opportunity to top a competitor based on the relationship.
The 2 large sales leasebacks that we did this quarter were really driven primarily on a relationship basis, although as we've already discussed Lifetime was shown doing select few players in this sector.
Okay. Thanks. That's helpful.
We'll go next to Todd Stender with Wells Fargo.
Hi, thanks. Just to beat a dead horse on the Lifetime deal. I recall you got to pick and choose somewhat when the BJ's wholesale portfolio went to a few buyers. Was that the case with this deal? I mean, how much more real estate could you have acquired and did you get first look?
There were just a select few firms in this business that got the first look. So we were not the exclusive one. And we did have an opportunity to help construct the portfolio that we ended up with.
Okay. That's helpful. And then just as part of the underwriting, with a tenant now that's owned by a private equity firm, is there an extra margin of safety that you factor in versus say doing a sale leaseback with an owner that may have a longer term ownership time horizon?
Well, we certainly approach the private equity driven transactions with caution for good reason. Generally, their time horizon is shorter in terms of their investment in the business than a corporate tenant driven transaction. However, in this case, the senior and executive management team elected to remain major owners of the company and continue to own it. So that was a bit unique. But even given that, you heard me earlier Todd walk through the metrics.
We structured this transaction very conservatively. So we feel very comfortable with that. But we certainly have the added comfort of knowing that the CEO and the management team are heavily invested in the equity of this company going forward.
Okay. Thanks, John. And Paul, your line of credit obviously expanded. It now has a $430,000,000 balance. How do you evaluate how big a balance remains comfortable, I guess, in your eyes?
Is it relative to how much availability you have? Is it a percentage of total debt? What kind of measurement sticks do you use?
Overall, we're always going to look at the overall leverage of the organization and that would be a piece of that leverage, right? So you can't just look at it by itself. The nice thing about having the larger facility is it just generally gives us more flexibility. It allows us to I don't want to say time the permanent capital markets, but at least be available when something is attractive to do either in equity or in bonds or whatever it might be. And having the larger line carrying a little bit more balance still doesn't jeopardize the liquidity that we'd like to have available there for our acquisition efforts.
So it's just as a net positive for us in terms of our acquisition approach going forward, having that liquidity and then having the flexibility to do something when the timing is right relative to the market. But we don't look at it by itself. We look at it as a piece of the overall capital structure and our primary exposure, if you will, to variable rate debt.
Okay. And then it looks like you used a 5 year term loan at a pretty low coupon to fund some of the Q2 acquisitions that were done at a cap rate closer to 6% than say your traditional 7%. Is it fair to say that we won't be seeing those low cap rates in your acquisitions going forward just because you'll be probably tapping longer term capital?
Yes. I think from a cap rate standpoint, what we'll be looking at are cap rates for the remainder of the year in the mid to upper 6s. And we really didn't fund that fund the acquisitions earlier in the year at more aggressive cap rates with shorter term debt because the cap rates were lower. It was really more a function of what I explained earlier And that was what we had in the 5 year window in our maturity schedule. And the banks were very supportive of us having a balance outstanding through them since our historical utilization of the line of credit had been minimal.
Okay. Thank you.
We'll go next to Rich Moore with RBC Capital Markets.
Yes. Hi, guys. Good afternoon. Paul, I have a question for you too on the expenses and the tenant reimbursements.
We calculate
an expense recovery ratio. And so we
look at the percentage tenant reimbursements and not a lot of extra you got a bunch of tenant reimbursements and not a lot of extra operating expenses. Is that the right way to think about it? Because as you do more acquisitions, right, you're going to assume some sort of tenant recovery rate that isn't 100%. And then why do you think that would have jumped in the second quarter?
Yes. I saw that dialogue in your piece. And any look at as we've mentioned EBITDA margins for the business I think is a very good way to look at it because we think we're very efficient not only in our G and A but in our property expense side. There's no trend there Rich. Each lease has its own element of negotiation or if it's an existing lease that we assume relative to the nature of what might be reimbursed or what we may or may not be responsible for.
So there's no real trend to look to there in terms expenses being reimbursed any more or less now or going forward. Other than to say that we expect that to be continue to be a very efficient line item, less than 2% of our overall revenues in the portfolio in the property expense area.
Okay, right. And then as you get acquisitions, I assume going forward, you're not going to get 100% recovery. So we got to think about as we grow your portfolio with acquisitions, we got to put some of that as non recovered expenses as well.
It depends on the type of acquisitions we're doing. The majority of them are all recoverable. So we would not anticipate that percentage of 2% moving very much. In fact, it may come down a bit, especially given some of the recent acquisitions we've made.
Okay. All right. Good. Yes, that's helpful. Thanks.
Then I'm curious, when you guys when you did your 200 basis point spread calculation to the cost of assets, to the cost of capital, what stock price did you use? You said it was a long term sort of view, but I mean like what roughly was the stock price you used to get something like that?
Yes. So it was just a shade under $50 It was 49.70 dollars If you look at the VWAP of our capital for the 1st 6 months of the year and look at our spreads on our acquisitions year to date based on that number, the spreads are 170 basis points. So 80% we funded 80% of the acquisitions we've done year to date. And based on the cost of the actual funding we've used, our spreads to our weighted average cost of capital were 200 basis points, which was the number you heard, Sung, that you gave earlier. Does that answer your question?
It does. Yes. Thank you, John. So as I think about yes, it does very much. Thank you.
As I think about going forward then at the current share price, you're not substantially below that. I mean, a little bit below that, but I guess it wouldn't hurt your spreads significantly even to issue equity here?
Our cost of capital overall right now is running just below 5%. So it's still attractively priced. So if we can continue to buy assets at initial spreads 150 5 basis points based on our anticipated cap rates for the remainder of the year. Those cap rates are still those spreads are still comfortably above our historical averages. So we'd be pleased with that.
Our cost of equity is reasonable at this level. And certainly our debt costs while they've come up a little bit, we can still issue 10 year debt right around 4%.
Okay, good. Thanks. And then the last thing I had was on your build to suit or your development pipeline. It seems like Steph, I'm assuming, is moving in and out of there because you had fewer projects, I think, but higher costs. I mean, do you have any sort of summary of what happened in the quarter?
I mean deliveries that kind of
thing? Sure. So Sumit can handle that. That fluctuates. It's a little higher.
We have just under $92,000,000 in development under development right now. And we funded at this point about $25,000,000 of that.
Yes, that's exactly right, John. We've got $65,000,000 of unfunded obligations. Most of the developments that you're seeing, Rich, is with our FedEx expansions. That continues to be a higher yielding investment for us. And those are investments that it allows us to continue to push out the leases beyond the original expiration when we do an investment for them.
Along with FedEx, we are also doing investments in AMCs. That continues to be a good investment. And we do have some build to suit on the retail side that I do not wish to disclose the name at this point, but those continue to be a higher yielding form of our investment opportunity set.
Okay. And so each quarter, Sumit, what do you think you'd add roughly to the pipeline?
Each quarter, our run rate has been right around this $90,000,000 unit has fluctuated from anywhere between $70,000,000 and it's been as high as 110,000,000 So about $90,000,000 seems to be right. We would like for it to be a bit more, given the size of the company. I think you've heard John mention that we would like to see it go as high as $250,000,000 but we've not been able to achieve that. So the run rate historically has been right around what you see it today.
Okay, great. Thank you guys.
Thanks, Rich.
We'll go next to Collin Mings with Raymond James.
Hey, thank you. Good afternoon. I guess my first question just as far as the mix of industrial going forward. I know obviously 2 large deals impacted the mix here in the Q2. But can you just talk about the deal pipeline as you're looking at more industrial deals?
And has there been any shift as how you think about just the investment grade mix historically pretty high on the industrial front? So just put us some more color on that if you could.
Yes. We're really reacting Collin to the opportunities we see in the marketplace. So we have very high retail numbers year to date and for the quarter. And we continue to see attractive industrial opportunities, but some of those opportunities are very aggressively priced today and we've elected to pass on them. So it's hard to predict the future, but we will continue to be active on the industrial front and look at the opportunities that fit our investment parameters and are priced appropriately for us.
And we'll certainly continue to look at both investment grade and non investment grade retail investments as we've done.
Okay. And then I guess kind of switching gears, just as far as on casual dining, I'm just curious your thoughts. I mean you guys have brought exposure down, I think it was north of 10% a few years ago, now down to about 4%. Can you just remind us how you're thinking about that sector, particularly just in context of Darren out there looking to sell assets at a 5.5% cap?
Yes. I mean we continue to look at the QSR and the casual dining sector. They each separately represent 4% of our revenues. We've always been cautious on casual dining as you know and as you alluded to. For casual dining investment for us, We want to see an operating concept that has positive trends.
We want to see really healthy coverage, coverage beyond what we see in our overall portfolio, probably 3 times or greater. We want to see rents that are approximately at market and we want to be at approximately replacement cost on our investments. So we have a high hurdle there. We have looked at some casual dining investment opportunities and we continue to do that. We haven't seen any on a large scale portfolio basis that meet our parameters for I'd say quality and pricing.
But we would certainly consider the right type of cash flow dining transaction.
Okay. No, that's helpful color. Then just real quickly, can you give us maybe what the watch list that is a percent of revenue? I don't know if I missed that. And if there's been any shift on that
front? Yes. It's still at 1.2%, which represents about $150,000,000 in properties. And what I said earlier was on the dispositions front, if anything, I mean, we had budgeted for $50,000,000 in dispositions. If anything, that could tick up a bit and we may sell a little more and that's obviously coming from that watch list.
So we could pair it down just a shade. But it's been kind of steady right around 1.2% for the last several quarters.
Okay. Thanks.
Thank you.
We'll go next to Ross Nussbaum with UBS.
Hey, guys. It's been a long call, but I've got two questions for you. The first is on your releasing spreads or I guess more specifically the spreads when you've released to a new tenant. If I think back 10, 15 years ago to the Realty Income I grew up with, there was a lot of talk about making sure that the rents on on acquired properties on the portfolio were around market and that was one of the considerations for acquisition. So I guess it's a little disappointing to see these properties getting re leased down 30%, 35%.
What exactly is going on with it's not a completely insignificant number of properties that it's such a dramatic roll down in rent?
So, if you're looking at the year to date, I guess that's in our supplement is where you're getting that information on page 24 for everyone. Releasing to new tenants with and without vacancy, you're seeing a 30% roll down in rents. The issue there is simply those are that's the market. I mean, we're also disappointed that it's not higher. Overall, our leasing spreads are positive at 100 just under 103%.
We've executed more than 1900 lease rollovers in the company's history and have a lot of experience at this. The majority of the assets that we do release are released at a positive spread year to date, 105 percent of expiring rents to the same tenant.
Ware, maybe the follow-up is, if I looked at the entire portfolio today, do you have a sense of what the mark to market is on the entire portfolio?
With regard to rents?
Yes.
Yes. I mean there you can see it that we're roughly at market rents just slightly on the entire portfolio just slightly above. So there's not a very big differential between our contractual rents and market rents.
Got it. Okay. Second question I had is on the Walgreens acquisition. I know there's not too much you can say, but if I extrapolate based on the cap rate for the Lifetime Fitness deal and the average cap rate which you bought properties, it would suggest that the Walgreens pricing was close to 6% or I don't know, could it even below. I guess my question would be, why does it make sense at this point in the cycle when the private market, the 1031 market is going bananas.
Why pay up for the creme de la creme corner Walgreens location? Why is that the transaction that makes sense versus perhaps stepping a little further down the credit curve or just passing on that opportunity completely?
Yes. Well, that was a well structured transaction for us and I can't go into details on it, but it was certainly more favorable than what you're seeing in the 1031 market. And that's an industry and a tenant that we like a lot. You've heard us discuss quite a bit given what's happening in the healthcare industry and with our aging population and the performance of that company. So it was an attractive investment.
And I would say this, we don't do large institutional sale leaseback transactions without rental rate growth. That was the next question. In the private market, 10/31 market is back as you alluded to and we're seeing pricing there at the 5% area. We've even seen some 4 handles there. So there's a certainly a premium for the one offs that don't necessarily exist for the larger portfolios.
And there's certainly a relationship element to our business with them as well. Appreciate it. Thanks.
We'll go next to Chris Lucas with Capital One Securities.
Good afternoon, everyone. I promise I'll try to be brief here. John, just a follow-up question on the comments you just made about sort of the intensity or the competitiveness of the 10/31 market. Just wondering, does it make sense to sort of start ramping up your disposition program to take advantage of some of that arbitrage? What we're seeing now is we've been in a period for a while where there's been a portfolio premium where people were paying up to get more capital out the door.
That pricing has not become less expensive. What's happened is the banks have returned to the market for the one offs in the smaller portfolios and are lending quite aggressively. So you've seen that tenthirty one market pricing surge. And they're fairly equivalent across the board. There are a few opportunities as the one that I just described where the arb is more significant.
But we only want to sell properties that we don't want to own long term. And so we're not seeing enough of an ARV yet to crank Crest back up. But it's something we look at every quarter. So that's a good question. Okay.
And then just for you or for Paul, just sitting where we are today with capital market conditions as they are, if you had to make a decision about raising equity or long term unsecured debt, which would you have a preference for either under the current conditions? We'd be comfortable with either given the strength of the balance sheet and the pricing of both and we'd be comfortable with either right now. Okay. And then maybe a little more detailed question on the term facility. Paul, is there flexibility or ease if the capital markets present a great opportunity to easily prepay that and replace it with some more permanent capital?
Yes. It's fully prepayable without penalty at any time. Okay.
Great. Thanks a lot guys. Appreciate it.
Thank you.
The question and answer portion of Realty Income's conference call. I will now turn the call over to John Case for concluding remarks.
Thanks, Vicki, and thanks everyone for joining us today. We look forward to speaking with you this fall at the various
That does conclude today's conference. We thank you for your participation.