Good afternoon. My name is Emma, and I will be your conference operator today. At this time, I would like to Welcome everyone to the Realty Income Third Quarter 2021 Operating Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press the star one. Thank you. Julie Hasselwander, Investor Relations at Realty Income, you may begin your conference.
Thank you all for joining us today for Realty Income's Third Quarter Operating Results Conference Call. Discussing our results will be Sumit Roy, President and Chief Executive Officer, and Christie Kelly, Executive Vice President, Chief Financial Officer, and Treasurer. During this conference call, we will make certain statements that may be considered forward-looking statements under federal securities laws. The company's actual future results may differ significantly from the matters discussed in any forward-looking statement. 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. If you would like to ask additional questions, you may re-enter the queue. I will now turn the call over to our CEO, Sumit Roy.
Thanks, Julie. Welcome, everyone. Our strong relationships with all our stakeholders enable the success of our business, and we thank everyone listening for your continued support. Additionally, I would like to express my appreciation of our expanded Realty Income team for their tireless efforts in executing on our strategic objectives. Today, our business is at an inflection point where the advantages of our growing size and scale provide us an accelerating number of opportunities, compounding our aptitude for growth. We see momentum accelerating across all facets of our business as a result of the following growth catalysts. First, the depth and breadth of our active global pipeline remains robust. During the third quarter, we acquired over $1.6 billion of real estate across three countries, resulting in approximately $3.8 billion year to date.
We now expect to invest in over $5 billion of real estate in 2021, an increase from our prior guidance of $4.5 billion. Second, we believe our expansion into continental Europe during the third quarter will significantly deepen our addressable market at attractive spreads relative to our weighted average cost of capital, particularly given the comparatively low unsecured borrowing rates in the European bond market. Third, our asset management activities continue to generate strong results. At the end of the third quarter, our portfolio was 98.8% occupied, and we achieved a rent recapture rate of 107.2%, illustrating the relentless efforts of our asset management team and highlighting the quality of our real estate.
Finally, with the closing of the VEREIT merger, we believe our size, scale, and diversification will further enhance many of our competitive advantages, which we suspect should allow us to augment our investment activities in the future. The closing of our merger with VEREIT, as well as the anticipated and subsequent spin-off of substantially all the combined companies' office properties, which as previously announced, is expected to be completed on November 12, allows us to provide enhanced clarity on our near-term earnings run rate. To that end, we are increasing our 2021 AFFO per share guidance to $3.55-$3.60, representing 5.5% annual growth at the midpoint.
We are introducing 2022 AFFO per share guidance of $3.84-$3.97, representing 9.2% annual growth at the midpoint. Our 2022 guidance assumes over $5 billion of acquisitions and over $40 million of year-one G&A synergies we have identified as a result of economies of scale from the merger. These guidance ranges also assume that the anticipated spin-off of our office properties is consummated as anticipated on November12 th. With the closing of the merger, our combined company eclipses $50 billion in enterprise value with size and scale to support numerous growth verticals, providing flexibility to close large transactions without creating concentration risk. Additionally, through this merger, Realty Income has inherited a pipeline, platform, and talented acquisition team focused on sourcing high-yielding product that will be additive to our existing pipeline.
Further, over time, we expect to generate meaningful earnings accretion by refinancing VEREIT's outstanding debt, supported by our comparatively lower borrowing costs driven by our A-/A3 ratings and capacity to issue debt in lower-yielding markets. Finally, we are excited to integrate the capabilities of many talented VEREIT colleagues into the Realty Income business as we continue to execute our growth initiatives as one team. Now turning to the results for the quarter. We continue to add attractive real estate to our portfolio at a rapid pace. During the third quarter, we sourced nearly $24 billion of acquisition opportunities, ultimately selecting and closing on less than 6%. Of the $1.6 billion of real estate we added to the portfolio in Q3, the largest industry represented was U.K. grocery stores.
On a revenue basis, approximately 38% of the acquisitions made during the quarter were leased to investment grade rated clients. Our total investment grade client exposure remains approximately 50%. The weighted average remaining lease term of the assets added to our portfolio during the quarter was 13.4 years. In aggregate, all of our acquisition activities during the quarter resulted in healthy investment spreads of approximately 164 basis points. As of quarter end, our portfolio remains well diversified, including over 7,000 assets leased to approximately 650 clients who operate in 60 separate industries located in all 50 U.S. states, Puerto Rico, the U.K. and Spain.
Giving pro forma effect to the closing of the merger and the anticipated spin off of our combined office assets as of September 30, 2021, our portfolio now includes over 10,500 assets located in all 50 U.S. states, Puerto Rico, the U.K. and Spain. Our international pipeline continues to add meaningful value to our portfolio, and we believe it will remain an important driver of growth going forward. In total, of the nearly $24 billion in acquisition opportunities that we sourced this quarter, approximately 34% was associated with international opportunities. During the third quarter, we added approximately $532 million of high quality real estate in the U.K. and Spain across 31 properties, bringing our total international portfolio to over $3.2 billion. This quarter, our international acquisition accounted for approximately 33% of total acquisition volume.
As previously announced in September, we made our debut acquisitions in continental Europe through a sale leaseback transaction with Carrefour in Spain. Subsequent to quarter end, we announced the completion of an additional Carrefour transaction in Spain, bringing the value of our continental Europe portfolio to approximately EUR 160 million. We are optimistic about our momentum in Spain as we look to replicate the success of our international growth platform throughout the continent with best in class operators who are leaders in their respective industries. The health of our core portfolio remains of utmost importance as we continue to expand our platform. At the end of the third quarter, occupancy was 98.8% based on property count, which represents an increase of 30 basis points as compared to last quarter.
During the quarter, we released 50 units, recapturing 107.2% of expiring rent, bringing our year-to-date recapture rate to 105.5%. We continue to report on quarterly recapture rates and believe this is one of the most objective ways to measure underlying portfolio quality in the net lease industry. Since our listing in 1994, we have executed over 3,800 re-leases or sales on expiring leases, recapturing over 100% of rent on those re-leased contracts. At this time, I'll pass it over to Christie, who will further discuss results from the quarter.
Thank you, Sumit. This quarter our business generated AFFO per share of $0.91, strengthened by our acquisitions pace and the collection of almost 100% of contractual rent in the third quarter. During the quarter, our theater clients paid approximately 99.6% of contractual rent, representing a meaningful improvement compared to the 38% collection rate in the second quarter. We continue to be encouraged by the strong box office performance of recent blockbuster releases, which we believe signal the long-term viability of the theater industry. I was looking forward to the release of the James Bond film, No Time to Die, for months. Based on recent box office numbers, so were many across the globe. We currently have 34 of our 79 theater assets on cash accounting with approximately $37 million of non-straight-line reserves on our balance sheet.
Like our business strategy, our approach to evaluate when these 34 theater assets move back to an accrual basis and the appropriate time to reverse the allowance for bad debt reserves will be conservative and data driven. More specifically, we will assess the likelihood of collecting on these amounts by evaluating store level and industry-wide data in conjunction with sustained payment of past due rents over a healthy period of time. As we continue to expand our platform, we will remain steadfast in prioritizing low leverage and a conservative balance sheet strategy while financing our growth initiatives with attractively priced capital. At the quarter end, our net debt to adjusted EBITDA ratio was 5x or 4.9x on a pro forma basis, adjusting for the annualized impact of acquisitions and dispositions during the quarter.
Our fixed charge coverage ratio hit an all-time high for the third quarter in a row, coming in at 6.1x . During the quarter, we raised over $1.6 billion of equity, approximately $594 million, which was through an overnight offering that closed in July, and the remainder primarily through our ATM program. During the quarter, we also issued our debut green bond offering, a $ 750 million multi-tranche sterling-denominated unsecured bond offering, which priced at a blended yield of approximately 1.48% for an 8.8-year blended tenor. We look forward to continuing to partner with our clients around sustainable practices in accordance with our Green Financing Framework. Now, I'd like to hand our call back to Sumit.
Thank you, Christie. In summary, we are energized and pleased by the momentum we see across all areas of our business. We are proud to have closed the merger with VEREIT, and we expect the benefits of this transaction to be broad and lasting, enhancing our competitive advantages and generating shareholder value for years to come. Going forward, the possibilities of our business will be constrained by only our imagination. We look forward to continuing to execute on our strategic growth initiatives to strengthen our position as the global consolidator of the highly fragmented net lease space while providing our shareholders with compelling risk-adjusted returns over the long run. At this time, I would like to open it up for any questions.
I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Again, please limit yourself to two questions. If you would like to ask additional questions, please re-enter the queue. Your first question comes from the line of Nate Crossett with Berenberg. Your line is unmuted.
Hey, thanks for taking my question, and congrats on the merger.
Thanks, Nate.
Appreciate the color on the pipeline. Maybe you could give a little bit more detail just heading into the end of the year and into next year. You know, what does the mix look like in terms of Industrial vs Retail, you know, U.S. vs Europe? You know, was there a lot of overlap in the deal pipeline between Baird and O before the merge? Then I'll ask my second question at the same time. Just if you can comment on pricing dynamics, U.S. vs Europe.
Thank you, Nate. Good questions. Yes, we are so happy to have the merger behind us. In terms of the composition of, you know, the pipeline ahead as well as what we've achieved. You know, what we've shared with the market that they should expect, the international acquisition to represent about 1/3 of our acquisition volume going forward. In terms of pricing, you know, surprisingly, when I looked at the spreads that we are generating, either here in the U.S. and comparing it to what we were able to do in Europe, they are very similar for this quarter. In some quarters, you know, we've seen that we were able to get slightly higher yields in the international markets, and in other quarters, it has been the opposite.
There's really, you know, the way we are thinking about our portfolio is through the macro lens that we've identified what it is that is of interest to us. You know, the area that we play in Europe is slightly narrower, and it's a function of the product that's available than what we play in the U.S. In terms of Retail vs Industrial, you know, as much as we would like to do more Industrial, the pricing in this market, you know, keeps us fairly constrained to that 10%. On a good quarter, we are able to get to that 15%-17% zip code. That's the composition of the Industrial makeup of the overall acquisition. The rest of it is primarily Retail.
In terms of investment grade vs non-investment grade, we've said this in the past, and I'll repeat it again. You know, when we look at credit and we do our own analysis, we don't go out saying if it's a non-investment grade credit, we immediately disqualify it for consideration purposes. If you look at what we were able to achieve in the third quarter, only 38% of what we did was investment grade. So we are very comfortable, you know, looking at non-investment grade. Non-investment grade does not necessarily mean sub-investment grade. It just means that it doesn't have a rating from one of the two major rating agencies, and/or it might actually have a sub-investment grade rating. We are very comfortable with that.
The last question that you had as a sub part to your first question was in terms of there being an overlap with what we are inheriting from VEREIT. There really isn't much. There are certainly certain, you know, acquisition opportunities that we would find VEREIT as a competitor. They played in an area that we believe can truly be additive to our overall platform in the high yield side. We are so blessed to inherit this team. We're really looking forward to being able to completely integrate them into our acquisitions team and have them continue to pursue the transactions that they were pursuing and potentially not be constrained by, you know, the cost of capital.
We genuinely believe that this is going to be an incremental to the acquisitions that we were able to achieve on a standalone basis.
Okay.
With respect to pricing, I think I sort of addressed that through my spread comment. Nate, I don't know if there's anything specific you want me to dive into.
No, that's all very helpful. Thank you. I'll get back in the queue.
Thanks.
Your next question comes from the line of Greg McGinniss with Scotiabank. Your line is unmuted.
Hey, Sumit.
Hi there, Greg.
Hi, Christie. So thinking about the merger with VEREIT, where they have, you know, I think maybe fewer true triple net leases on average than you guys do. You know, what % of leases after the acquisition and spin are truly triple net or will truly be triple net? And will you be looking to offload some of those non-triple net leases? Then in general, just how should we be thinking about the level of dispositions vs the $5 billion or more of acquisitions in 2022?
Yeah, good questions, Greg. Look, I think the only area where I felt like they probably had, you know, non-triple net leases was on the GSA side of the equation on the office sub-portfolio that they had exposure to. You know, otherwise largely, Greg, these are triple net leases. If you think about how this particular portfolio was put together, we'll be able to give you a lot more color, you know, once we've got it all integrated. I'd be very surprised to find gross leases or preponderance of gross leases on the Retail side and the Industrial side of the equation.
You know, obviously Industrial products, the landlord tends to be responsible for things like roof and structure, which one could argue is not a pure triple net lease, but that is largely the same case with respect to our portfolio as well. The property maintenance is still the responsibility of the client. You know, the property taxes, the insurance on those buildings are still the responsibility of the client. We still view those as predominantly net leases. With the separation of the office assets through the spin and the GSA leases, I think we are going to be, you know, largely a net lease portfolio, very similar to the one that we have. I don't think that that's going to pose any major issues, Greg.
Okay. Yeah, I was just looking at their various disclosures, has that around 30% on the Retail side, 40-something% on the Industrial side is double net. You know, I get your point on the level of obligation that's really entailing. In terms of the level of dispositions we should be thinking about, whether there's any cleanup there or just in general vs the $5 billion of acquisitions.
Yeah. So, you know, we've been doing about $100 million-$150 million. You know, the odd year we've gone past $200 million in dispositions on a stand-alone basis. We would like to inherit and really do a similar analysis on the portfolio that we are inheriting with VEREIT to see if that needs to be altered. You know, a lot of the capital recycling that they were doing pre-merger was on the office side of the equation. I don't know if the number will dramatically increase beyond a linear you know, extrapolation of going you know, adding another $10 billion, $14 billion of assets. So maybe the $150 million becomes $250 million or $275 million.
Give us a quarter to digest this, and filter it through our own asset management lens, and we'll be able to come back to you with a lot more precise indication. We don't suspect that it's going to be dramatically different from the run rate that we were doing on a stand-alone basis.
Okay. Just one quick point of clarification on the $24 billion of sourcing opportunities. You said 34% was international. Is that all of Europe, or is that just U.K. and Spain for now?
Primarily U.K. and Spain. We are certainly looking at other geographies that we have identified as core to our expansion objectives. It is primarily in the U.K. and in Spain.
We could see that source number go up as you start looking more intensely at other countries.
As we start expanding, yes, you should expect that to go up.
Okay. Thank you.
Sure.
Your next question comes from the line of Brad Heffern with RBC Capital Markets. Your line is open.
Hi, Brad.
Yeah. Thanks, everyone. Hey, how are you? On the acquisition guide for 2022, you know, you've talked about how the VEREIT team, you know, is additive, but then the guide is the same over $5 billion for 2022. Is that just, you know, beginning of the year conservativism because, you know, there's limited visibility in the pipeline, or how should we think about that?
Look, what did we start this year with? You know, it was right around $3.25 billion. We went up to $4.5 billion, and now we are above $5 billion. We want to come out with numbers that we are, you know, we have a very high level of certainty associated with it. As we start to develop our pipeline and visibility, we expect that number to go up. We don't want to come out with a number that we feel like is overly aggressive coming out of the gate. This has been something that has been, you know, very important to us to be able to deliver to the market what we say we will deliver.
As such, you should consider this to be our initial guidance. The hope is, we can do better than that. With time and as soon as we are in the next year, we hope to be able to get more precise around what the acquisition guidance will ultimately turn out to be.
Okay. Makes sense. Maybe for you, Christie, also on the 2022 guide, is there anything in there that, you know, would be considered kind of one-time in nature, like maybe a reserve release from the theaters or anything like that we need to take into account?
Hi, Brad. There's nothing of a one-time nature, including reversal of the theater reserves.
Okay. Thank you.
You bet.
Your next question comes from the line of Haendel St. Juste with Mizuho. Your line is now open.
Hello out there.
Hi, Haendel.
Hi, Haendel.
Hey. Sumit, I was intrigued by your comments. You mentioned inheriting a team that experienced acquiring higher yielding assets that will be added to your platform. You also mentioned being very comfortable acquiring higher yield. I was gonna ask you if this quarter's 38% investment grade volume was an anomaly, but it doesn't sound like it is. Maybe can you talk us through your thoughts on portfolio strategy with regards to high grade going forward, and if you're signaling perhaps a slight shift in your overall thinking or portfolio strategy?
I'm here to alleviate any confusion, Haendel. You know, if you look at our top 10 clients, Haendel, we have Carrefour that shows up there, and Carrefour is a non-rated company. Yet, if you were to look at its balance sheet and you were to look at its credit metrics, you know, it would imply a very strong investment-grade credit. That does not show up in the 38% investment grade. We've been playing in the area that we've identified coming out of the strategy sessions that we've alluded to in the past. We feel. Sorry, it's actually Sainsbury's, not Carrefour. Carrefour is actually rated BBB.
You know, when we come out and we share with you the actual investment grade numbers, it is truly an investment grade rating by either S&P or Moody's. We play across the spectrum. We are so focused in the area that we've identified as our area of growth that, you know, are we as focused on some of the high-yielding product that, you know, our inherited team from VEREIT was focused on? Potentially not. Are we going to do everything that VEREIT was acquiring as a standalone company? Probably not.
You know, we are trying to create a team, and we truly believe their team to be complementary to ours, and now it's one team that is going to be able to play across the credit spectrum and be able to, you know, truly be an incremental source of acquisitions for us going forward. So, you know, there'll be quarters where we do more than 38%. In fact, we've done up to 50%, 60% of investment grade, and then there'll be other quarters where we don't. So I don't want you to put too much weighting to, you know, this headline number of how much investment grade are we actually pursuing. Because as I've said to you, that's a by-product of our, you know, strategy, not what drives our strategy.
Great. I appreciate the thoughts and clearing that up. Christie, not to beat a dead horse. We've talked about it over the last quarter or two. It's been asked on the call today, and I guess I'm really still a little, I don't know, perplexed or still surprised that there hasn't been the recognition of revenues in the movie theater side. You pointed out a number of the positive industry dynamics that the industry is experiencing here. Is it just more time? It sounds like certainly right now there isn't any of that in your 2022 guide. Just trying to square your comments with, you know, the, I guess, the lack of recognition or any sense of timing on that.
Sure, Haendel. It really, I mean, in a nutshell, it really is timing. We experienced payoffs in the third quarter according to our deferred arrangements, the handful of theater properties and they're back on pool accounting. We'll continue to evaluate on an asset by asset basis. You know, we still have you know, remnants of COVID out there. We want to make sure that we're evaluating this not only on an asset by asset basis, but also just in terms of what's happening from a macro perspective. More time, and we'll be back to report to you.
Okay. Fair enough. Thank you.
You bet, Haendel.
Your next question comes from the line of Caitlin Burrows with Goldman Sachs. Your line is now open.
Hi, everyone. Congrats on the merger and all the recent progress. Maybe digging a little deeper on the pipeline. I'm wondering if you can talk about the difference in what you're interested in abroad vs the U.S. I think you mentioned that the abroad pipeline might be a little bit more narrow.
Yeah, Caitlin. It's just not as developed, you know. Then partly it's driven by being land constrained. You know, you don't have as many freestanding triple net opportunities, you know, in terms of various industries and various tenants playing in that space. Obviously, the size of the actual market is 2x what we have here in the U.S.
You know, the number of industries that lend itself to sort of this triple net concept are a bit narrower. We've already talked about grocery as being one of the areas that we'd like to focus in on. Home improvement is another area. It is very, you know, unusual to find some of the other industries that we are exposed to on the Retail side, being available in mainland Europe. And that's really the point I'm trying to make. This is not a constraining factor because I think we put out some numbers, et cetera, sharing with you how much bigger the actual market is, the addressable market is in Europe that lends itself to, you know, net leasable investing.
It really is just a narrower group of industries that play in that space.
Got it. Okay. Given your larger size now, do you expect there to be any change in sourcing over the next year? As a result of that, do you think there will be any meaningful change in your acquisition cap rates?
I hope so. You know, I absolutely believe that, with the newly expanded team that includes, you know, folks from, what was VEREIT, we will be able to increase our run rate on the acquisition front, and we will be able to cover, you know, the credit spectrum a lot more precisely and acutely than we were able to do on a standalone basis. That should result in not only higher sourcing, but getting more transactions over the finish line. You know, that is absolutely one of the levers that we hope will play out for us.
Based on everything that we've seen and based on getting to know our new colleagues better, I absolutely believe that is going to play out next year and beyond. But time will tell, but that is our expectation.
Okay, great. Thank you.
Absolutely.
Your next question comes from the line of Ronald Kamdem with Morgan Stanley. Your line is now open.
Hey, congrats on the VEREIT merger. Just two quick ones from me.
Thanks, Ronald.
The first is just sort of going back to acquisition, and I think you've talked about what sort of a new $50 billion+ enterprise value, less concentration risk. There are just more opportunities that present themselves. I guess the question is really, is the team doing anything organizationally different to try to source those deals? Or is the point that historically when those deals have come up, you've had to pass on them, but now you can take a look at it? Thanks.
It wasn't that we were passing on deals, Ronald. You know, it was more along the lines of if you look at some of our industry concentration, they were starting to creep to, you know, double-digit ZIP codes and somewhat beyond that. You know, the complementary nature of what we are inheriting from VEREIT, I believe, helps us on a couple of industries. If you look at a few of our largest industries like convenience stores and groceries, et cetera, all of those concentrations on a pro forma basis is actually gonna come down. It gives us more capacity to aggressively pursue opportunities that we are finding incredibly compelling to try to get over the finish line. It just gives us more capacity. That's one.
The second is, you know, being a much larger company, and this is a more recent phenomenon. I think two years ago, maybe a little bit longer than that, was the first time I heard of a billion-dollar sale-leaseback opportunity in our space, and it was on the Retail side of the equation. We'd never heard of, you know, opportunities of that size. Even for us, if we had some prior exposure to the client doing a billion-dollar transaction, was going to sort of start to push the concentration risk issue. Now being, you know, 1.1.3, 1.4 times the size that we were, you know, it is less of an issue.
The size of sale-leaseback opportunities that are now in play are billion-dollar, you know, opportunities. Now, we haven't really seen. There have been announcements, but we haven't seen anything sort of get over the finish line on that front. That to us is exactly the type of transactions that we would like to be able to show up for and, you know, be able to do and be a single point solution for some of our clients that we perhaps would not have been able to pursue in our previous version. I think that really is what we feel will be one of the biggest beneficiary.
Also proactively to go to some of these larger companies and be able to say, you know, for large companies, by definition, doing a $500 million sale-leaseback doesn't really move the needle for them much. To be able to be a solution and provide multi-billion-dollar sale-leaseback opportunities for them, I think could be a lot more compelling. Those are the types of things that we'd be able to pursue, you know, post this closing. That we obviously thought a lot about in the past, and we have approached certain clients, but, you know, it was. We were guided by what we were hearing in terms of what is really relevant for some of these folks.
I think, look, time will tell, but it certainly creates the platform for us to now be able to, you know, pursue some of these transactions which we were not able to as aggressively pursue in the past. Ronald?
My second question was just going to 2022 guidance. Obviously, I appreciate the transparency, and I can appreciate these are preliminary numbers. When I think about the AFFO guidance range, can you maybe share what that assumes in terms of same-store rent growth and the assumptions for reserves for credit losses?
Yeah. You know, we obviously gave you a couple of numbers when we came out with this. The point of coming out with a guidance at this point in the cycle, which is non-traditional for us, was largely driven by this acquisition that we did of VEREIT. There was a lot of uncertainty around, you know, what does pro forma Realty Income really look like post-separation of the office assets? This was our attempt to sort of address that, you know, going forward. You know, you should
Of course, as we learn more about the portfolio that we've acquired and we look out into the future, and we more importantly digest the $5 billion acquisition guidance that we have for this year, I think, you know, we'll be in a much better position to give you much more precise numbers on same-store growth, et cetera, et cetera. For right now, you should assume it to be the 1% that we usually sort of point to.
Great. Thank you.
Sure.
Your next question comes.
And, uh-
Oops, sorry. Your next question comes from the line of Brent Dilts with UBS. Your line is now open.
Great.
Hi, Brent.
Thanks, guys. Hey, Christie. So look, I've just got a qualitative one at this point. But with the acquisitions in Spain during the quarter, could you talk about what you learned from the transactions and just how does that impact your approach in continental Europe going forward? I think in recent calls you guys have spoke about just trying to learn the local markets, and there's a lot of nuance to it. Maybe you could just provide a little color around your experience there.
Sorry, are you asking us what is our filter of going into new markets? Is that the question, Brent?
No. Sorry, assuming. It's more just what did you learn specifically from the process itself as far as, like, nuance to the deal structures or the negotiations or just anything about the market that maybe you picked up?
Yeah. Brent, I'll tell you very honestly, we did a lot of homework before we actually went into any particular market. We looked at transactions that had taken place in the past. We tried to understand the nuances of the structures. We took into account the tax implications. A lot of the homework was done prior to us actually engaging with potential clients or the advisory community to start to pursue transactions. I would say that we weren't overly surprised, you know, by the structure of the deals that we've been able to get over the finish line. The one thing that has surprised me personally, and I don't know if Neil and Mark are gonna share in my comment, but is the volume comment. You know?
I do believe that we have been able to create these relationships that have cemented too and have, you know, translated into subsequent transactions much more quickly than what we had originally thought. This is very much a relationship-driven, you know, market, which we anticipated, but not to the extent that we've seen it play out. They're looking for long-term partners. They're looking for, you know, partners that are not in the market to flip out assets and that is right down the fairway for who we are and how we believe in generating value for, you know, our investors long term. The certainty of closing is incredibly important, far more so than perhaps here in the U.S.
It's not that certainty of close is not important, but they are much more price sensitive here in the U.S. than perhaps in continental Europe, as well as in the U.K. Reputation, size, scale, the fact that we do what we say does seem to be weighed a lot more significantly in all of Europe than what we had anticipated. That's where the surprise came in. Not in terms of the duration of the lease or the cap rates or the growth that we find embedded in these leases. A lot of that was known to us before we went into these markets.
Okay. Great. That's it for me, guys. Thank you.
Sure.
Your next question comes from the line of John Massocca with Ladenburg Thalmann. Your line is now open.
Good afternoon.
Hi, John.
How's it going, Christie?
Hi.
So just looking at kind of the leasing spreads, on, you know, kind of renewals and kind of re-leasing of vacant assets. It's a third quarter where you've kind of been well above I guess what, even kind of recent historical levels. Do you think that kind of above 100% recovery is sustainable here, or is that maybe more a reflection of where we are in kind of the macroeconomic cycle, given the pandemic?
John, that's a good question. You know, if you're asking me, can we do, you know, positive 7% with next to no capital investments every quarter going forward? I think the answer is probably no. I do think that over the last eight, 12, and even right during the pandemic, the kind of re-leasing that we've been able to achieve, without a bunch of capital investments, is a testament to the quality of the portfolio that we have. Much more importantly, it's a testament to the asset management team under the tutelage of Jane that we are able to generate these numbers.
I feel like if you look at the trend, and you look at what we've been able to do over the last three, four years, we have generally achieved north of 100% re-leasing spreads. This, by the way, includes not just clients who are renewing an option, but also new clients that we are bringing in into either empty buildings or buildings that are about to go empty. This is the complete picture of what we've been able to achieve. That is one of the points that we've been trying to talk about, that our business, you know, on a normalized basis, is going to become a seven-year vault business. A lot of value is either gonna get created through this channel or not.
We've been anticipating this and building out our asset management team in anticipation of you know being able to generate the kind of results that we are posting on a quarter-by-quarter basis. You know we feel very good that we you know and we usually target above 100% every quarter and we've been able to do far better than that. You know I'll leave it at that.
Okay. And then switching gears a little bit back to international. I think of kind of maybe pre-pandemic, if you looked at kind of cap rates for the U.K. acquisitions vs the U.S., right? U.K. was always, you know, fairly significantly lower than U.S. acquisitions, and that, you know, spread has kind of disappeared. You know, both are kind of on top of each other in terms of kind of day one cap rate. Is that a factor you think of macroeconomic pushes and pulls, you know, interest rates, et cetera, or is that, you know, more reflective of different kind of investments that you're targeting either internationally or here domestically?
It is certainly the latter. You know, if you're looking at, you know, grocery businesses here in the U.S., there's been a tremendous amount of compression that we've seen on the cap rate side of the equation. I would say that the U.S. market has moved more towards the U.K. market than the other way around. There are differences to the lease structures, et cetera. Once again, I'm not gonna go into the details. What you see as the headline cap rate, yeah, you're seeing that they seem to be very close. You know, there are some interquarter variability.
Like I believe in the second quarter, we had a slightly higher cap rate associated with international, and it was a function of the type of assets that we got, and the length of the lease terms that we were able to achieve, which translated to higher cap rates. By and large, you know, the spread, which takes into account both the cap rate as well as the, you know, the cost of capital is very similar right now. Very, very similar in both these markets. I do think, you know, it's partly driven by we are playing in a much narrower industry spectrum in Europe.
We, you know, have been doing a lot more Industrial here in the U.S., and it sort of balances out, and it yields a number that you see as the headline number posted on our supplemental.
Good. That part was very helpful. Thank you very much.
Thank you.
Thanks.
Your next question comes from the line of Wes Golladay with Baird. Your line is now open.
Hi, everyone. Quick question.
Hello
... on the acquisition volume this year. Hey, Christie. When you look at what's driving the upside, is it more on the sale leaseback side or is it developer takeouts, broker deals? Just trying to get a handle on where the need is coming from.
It's a combination of, you know, all forms of development. We are doing takeouts. You know, we are actually financing 100% of developments. The one common thread is that in the vast majority of the cases, there's a lease in hand. You might see that there's a Retail asset where I think on the Retail side it was 93% occupied, and that's largely driven by a repositioning that we are doing. You know, we don't quite have the lease in hand for that one particular unit. You know, otherwise it's all built to suit.
We play across the spectrum, you know, providing all of the development funding as well as doing takeouts.
Okay. When we look to next year's guidance, you do have about $750 million of high coupon debt in 2023 that is due. Is it safe to assume that's not in the number or prepayment of that?
I'll let Christie answer that.
That's correct.
Okay. Thanks for taking the questions.
Thank you.
Thanks, Wes.
Your next question comes from the line of Katie McConnell with Citi. Your line is now open.
Hey, it's Michael Bilerman here with Katie. Sumit, I wanna come back on sort of the pipeline. Just come back on the $5 billion for next year. I take your comments, you're trying to be conservative, it's early, you wanna sort of see what the combination of the teams can do. How did you come up with the $5 billion? You didn't pull it out of thin air. There has to have been some rigor to come up with that. Can you just walk through sort of the analysis and that you went through to come up with that $5 billion?
Sure. Look, I think as we get more and more comfortable with the strategy that we are, you know, we are currently executing, Michael, it gives us a lot more confidence to be able to say, "Look, this is the product that we are seeing. This is the translation rate on that product, on the sourcing numbers. We feel very comfortable given the team and infrastructure we have in place, that we are going to be able to accomplish the numbers that we've posted." This year was a very interesting year for us because we had a very healthy pipeline, just like we do today, coming into the year. It was post-pandemic, and we didn't quite know how things were gonna play out.
We felt very good about coming in and saying $3.25 billion, which we have since revised a couple of times. As we're getting more and more comfortable with the new markets that we are entering into, with the sourcing volumes that we are seeing, with the maturation of the team that we have in place, that's what is giving us the confidence. In the beginning, I used to, you know, talk with my colleagues, and we would earmark about 20%-25% international. Well, today it's closer to 30%-35%. You know, we built out the team in the international side. We have a much more mature team and a fantastic team on the U.S. side. Now we're going to inherit a group of veterans from this acquisition.
That's really the, you know, the build up that we've done internally, and we feel fairly confident about to come out and say, "Look, this year we're gonna do north of $5 billion." We should be able to do that with the level of visibility and one year behind us now in 2022. That's how we came up with that number.
Right. Which I guess hearing that would sound extraordinarily conservative, given all the arrows that you have in your quiver to be able to execute additional acquisitions, especially given your other comments about being a bigger company allows you to take on different risks, which arguably being a big company, if you went out and did a billion-dollar portfolio and it had $100 million of assets that you didn't want, well, $100 million or $50 billion ain't that much. How does that sort of play into your thinking about deal flow from here?
I think you and I talked a little bit about this, I know if it was last quarter or the quarter before, in terms of your willingness to now accept what previously was, you know, larger risks, that you may be willing to take today in terms of either type of asset, location of asset, credit of tenant, all the variety of things that may have made you pass on deals before.
Yeah. You know, I hope what you're saying is exactly right, and a year from now we have a number that is far in excess of the $5 billion that we are coming out with, Michael. What we don't want to do is have a particular number dictate our decision-making. We wanna come out and you know, this is right along the lines of how we've operated the business. This is the largest acquisition volume number that we're gonna be coming out with in our history. You're right. This is by design that we've created all these avenues, and we should be increasing our guidance. Perhaps there is a level of conservatism. But you know, we would like nothing better to come in in February and revise our numbers and say, "You know what?
We've had a chance to revisit and be able to, you know, come in and with a high level of confidence, given all of these other new strategies that we are putting a lot more effort into, i.e., higher yielding, newer markets, being able to, you know, have one quarter under our belt in Spain, figuring out what we can or cannot do there. All of that hopefully will translate into higher numbers.
Right
You know, this is where we feel that we don't want to overpromise and underdeliver.
Yep.
That's the reason why we're coming out with what we're coming out with.
Then in terms of just from a corporate perspective, I assume, Sumit, that you're going to talk to large tenants that have a lot of real estate on their books. You are much better equipped today at your size to be able to do those elephant hunting types of transactions. How active are you in going to those corporations that have the real estate on their books where you can do a direct deal in a much larger scale? You know, are those further along? I guess, do you have other capital partners? As we've seen, there's a lot of institutional capital that would love to get access to, you know, the type of portfolios and higher yielding levered plays that you're doing.
I'm just. I'd like to know a little bit more on that front, whether we could expect that to be a much bigger part of the story.
You know, in the past, we had to consider partners when we were coming across these multi-billion dollar sale-leaseback opportunities. I think the need for that has diminished post this acquisition. We had inbounds from investors who wanted to, you know, participate on these one-off transactions, larger transactions outside of the realm of the public eye. We've largely stayed away from that, because we felt like, you know, the transactions that we were actually seeing in the market that was near term, we could handle all on our own. We haven't had to pursue a partnership path, you know, very aggressively. I think the need for that has diminished even more so now, with this pro forma for the VEREIT transaction.
I do believe that our willingness and desire to more actively pursue, you know, potential clients that we've talked about, that we might want to speak with and engage with is a lot higher today, given that the concentration issues that we could have entered into, you know, are somewhat muted now. I do think that those types of conversations are going to be a little bit more front and center in terms of what we do.
Yep.
We are going to do it much more proactively. That's correct.
Okay. Then the second topic, last topic is just about the office spin. Obviously when you announced the transaction, there was a discussion about not, you know, having a plan in place to deal with those assets that you didn't want, and be able to contribute the office assets on your balance sheet. You said you were gonna pursue two paths. You'd have the spin as your basically backup option, and look at a sales process. Can you talk us through sort of, you know, what led you down the path of an office spin and thinking about the dyssynergies from a G&A perspective, how you thought about the value that you would be delivering to your combined shareholder base vs a sale and taking the cash? Why spin vs sale?
You know, you should assume that when we discussed the separation of the office assets, we were very clear with the market that we are gonna pursue, you know, either a spin or a sale. We did. Where we concluded going through those two parallel paths was that the spin is a far better option given, you know, where we were coming out on the sale side than, you know, not, which is precisely why we decided to choose to go down the spinning of the office assets. You know, putting a team that was very familiar with all of those assets, had been working very hard on asset managing those assets, was very capable of creating value longer term. What we
The analysis that we went through was to say, "Okay, you know, they have a thesis. It's a thesis that makes sense. There are some tailwinds in that particular sub-sector, given the success that they've been able to achieve, over the last couple of years." You know, you look at that, and then you sort of see what they can do with this portfolio going forward. You know, from an alternative perspective, this seemed like the absolute right alternative for us to pursue, despite the fact, you know, that, selling the assets would've been an easier, step for Realty Income to take.
You know, we did pursue both those efforts in parallel, and this is the path that, on a risk-adjusted basis, yielded the superior outcome for us, and that's the reason why we pursued it.
Okay. Thanks for the time.
Sure.
Your next question comes from the line of Josh Dennerlein with Bank of America. Your line is now open.
Yeah. Hey guys. Hope everyone's doing well.
Hi, Josh.
Hello.
Hello. Now that the VEREIT merger is behind you know, I'm curious. You added a bunch of teammates. Any kind of skill set that maybe was brought in that would help you guys widen the aperture?
Yeah, Josh. That's what we were-
And-
Yeah. Sorry, I didn't mean to interrupt. Go ahead.
No, no. Please, please.
That's what we've been alluding to, Josh, when we, you know, when we are talking about being able to have a team that is very capable of playing across the credit spectrum, for a lack of a better phrase. You know, the higher yielding assets, the lower yielding assets, and being able to cover that entire spectrum with a much broader team, that is one of the biggest advantages that we are inheriting through this acquisition. There are other advantages of teammates that we are inheriting, not just on the acquisition front, but also on, you know, when you look at some of the data analytics work that we are planning on doing, some of the process reengineering work that we are doing.
They have a few very talented folks in their team that will become part of some of these opportunities that we are already building out and executing upon. Be able to be tremendously additive and help us accelerate some of these opportunities to the finish line and create even more efficiency. I am so proud of the team that we have inherited, and it's circa 100 people that will really help us become a complete team. Of course, help us absorb north of 3,000 properties, which is not a small feat.
Got it. My other question would, I guess, relates to dividend strategy going forward. Just kind of curious to hear your thoughts on maybe how the board thinks about the payout ratio and retained earnings.
You know, our payout ratio is in the high 70s% today. We will always be the monthly dividend company. It took us over 25 years to become part of the Dividend Aristocrats Index, the S&P 500 Dividend Aristocrats Index. You know, this is very core to our strategy going forward. You know, in years where we can grow 9.5% or 9.2% on the midpoint of the range that we've just shared with you, that will just continue to help us, you know, grow our dividends in the future. There will be no change to that strategy of annual growth on the dividend going forward. Really no change, Josh.
I just wanted to make sure, given that you asked the question, that I emphasized how important and core dividend growth is to Realty Income. Nothing that we've done either recently or in the past is going to change that.
Got it. Thank you.
Sure.
Your next question comes from the line of Linda Tsai with Jefferies. Your line is now open.
Hi. Good afternoon.
Hi, Linda.
Hello. With 85% of your leases having some type of contractual rent increase, can you remind us what kind of increases you obtain on the European leases vs domestic? Across the entire portfolio going forward, what might the average weighted rent increase look like, you know, vs what it is now?
Yeah. Linda, I'm not going to give you precise information. I think it is of strategic importance to us to not be that precise on growth by geography. I will tell you that 85% of our leases have contractual growth. Either they are in the form of fixed growth, or they are in the form of CPI adjustments, or there are, you know, percentage rent clauses into the contract. It's one of those three, you know, variations that make up the growth profile. You can continue to underwrite to a 1% same-store growth for our business going forward. We will update you as and when warranted, but for right now, that is the assumption you should have for your models.
Thanks. Then how should we think about the pace and mix of capital raising activity in 2022 as you move forward with, you know, a +$5 billion-dollar acquisition run rate?
Um-
I think. Go ahead, Sumit.
No, no. Please, Christie, go ahead.
I'll just kick it off to say I think, Linda, you can expect that to be consistent with our performance this year in funding our business and continuing to pursue a very competitive cost of capital while maintaining our net debt to EBITDA.
Thank you.
Thanks, Linda.
Your next question comes from the line of Chris Lucas with Capital One Securities. Your line is now open.
Good afternoon, everybody.
Hi, Chris.
Thanks for taking my questions. A lot of the questions have been asked and answered. I guess just, Sumit, you know, given the scale of the company at this point and where your credit rating is, I guess I'm just curious as to your conversations with the rating agencies post-merger. If you've gotten any flexibility or indication from them that you have more flexibility on your leverage side to maintain those very high credit ratings.
I'll share the headline, but I'll let Christie speak to this point because she actually had the conversation along with Jonathan with the two credit rating agencies. They were very supportive. When we in fact went back after our third quarter announcements and spoke with them, you know, they were again very complimentary. They saw the capital raising that we did and essentially, you know, front loaded the funding of our acquisition pipeline. They continued to, you know, reaffirm their current stance of A-, A3 rating and a stable outlook. We feel like we, you know, of course, we're gonna have two months of earnings associated with this closing. All of their balance sheet, day one.
The numbers, you know, are going to look a little bit off. On a pro forma basis for annualized earnings, it's going to be right where, you know, where we play and where the rating agencies are incredibly comfortable. I don't see us being put on any sort of a negative watch or what have you. We've tried to be very transparent. We've shared all the analysis with the rating agencies. We feel very confident that they will continue to support us and maintain us at the current levels.
Yeah.
Christie
That's a good-
Come to Matt.
I was just actually gonna flip it the other way. I'm wondering whether the scale of the company and the diversification of the portfolio is going to allow you to do more leverage and keep the rating. That's really where I'm going with this.
That's a good question, Chris. I don't know the answer to that. It's very difficult to even enter into a hypothetical with the rating agencies about that particular scenario. They tend to be a bit of a black box, you know. We didn't change our leverage profile but, you know, when we were on the way up. This, I think, lends credence to the comment you're making, Chris. We can't expect that. Truth be told, we are very happy with A-, A3 rating. I think. I don't know what the incremental benefit would be, you know, getting to an A, A2 rating. I don't know if it's going to be as significant as going from BBB+ to A-, you know.
It's a good question, and one that I think now that you've asked, we'll pose to the rating agencies to figure out how they're gonna think about this.
Then just a sort of secondary question. When you think about how you wanna finance your business, you mentioned I guess European rates are more attractive right now than the U.S. for financing. Would you think about financing at a higher level relative to asset base in Europe at this point than you do in the U.S. from a debt finance perspective? How high would you go?
Yeah.
We-
Look, for us, Chris, we've been very clear about, you know, what the limiting factor has been for us in Europe. We want to use domestic capital to finance as much of our acquisition as possible. The limiting factor is always gonna be the asset value. You know, that's one of the biggest advantages that we have, is we can raise debt in any geography. You know, in an environment where we see here in the U.S., there's a rising 10-year U.S. Treasury, not so much today, but expected. You know, we could do a lot more on the unsecured side, assuming we continue to grow in the U.K. or in mainland Europe, as we grow out there.
The constraining factor will always be, you know, what's on the left side of the balance sheet, and does it support the raising or not. Could it be more levered there than here in the U.S.? Absolutely. That's one of the big advantages of why we did what we did. On a fully consolidated basis, which is how we think about our business, you know, we are very comfortable implementing that particular strategy.
Super. That's all I had today. Thank you so much.
Of course, Chris. Thank you.
Thanks, Chris.
Your next question comes from the line of Spenser Allaway with Green Street. Your line is now open.
Hi, Spenser.
Thank you.
Hi. I know you guys spoke about development earlier. Can you maybe just more broadly talk about how the development economics vary between the U.S. and Europe? If possible, can you just provide some color around what kind of yield you're expecting on the one U.K. development you have underway?
Hi, Spencer. We're gonna stay away from speaking about specific transactions. We just don't do that. You know, then I'm gonna be asked to remember 400 transactions, you know, properties that we acquired, what is the cap rate on the 388th property. It's just going to be impossible. That's really the reason why we are staying away from being very precise about you know, specific transactions. We try to report it to you on a fully consolidated basis. There is no doubt that we are able to get slightly higher yield on development projects than we would on assets that are you know, ready for delivery. That could range. You know, it could range anywhere between... By the way, that has compressed.
It could range anywhere between 25 basis points to, on the odd occasion, maybe 75, 80 basis points. It used to be north of 100 basis points not too long ago. For us, you know, we are a yield-driven business. Every incremental, you know, yield is a positive for us, Spenser. I do believe that in our supplement, we do provide that level of clarity. We do break out what the development yields are. You should be able to track that as part of our overall acquisition volume and how much of it is attributable to the development funding. You will see that it's, you know, it's definitely higher than what we are actually acquiring assets.
That's just a testament to our relationships and, you know, and being able to sort of balance out the overall portfolio. That's a strategy we'll continue to, you know, to play out.
Okay. Thank you.
Thanks.
Thanks, Spenser.
This concludes the question and answer portion of Realty Income's conference call. I will now turn the call over to Sumit Roy for concluding remarks.
Thank you everyone for coming, and we look forward to seeing a lot of you at NAREIT. Goodbye.