Realty Income Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
August 3, 2022

Key Takeaways

  • Realty Income invested over $3.2 billion in high-quality real estate in H1 2022 (including ~$1.7 billion in Q2) and raised its 2022 acquisitions guidance to over $6 billion.
  • The weighted average cash cap rate ticked up to 5.7% in Q2 (approximately 6.2% on a straight-line basis), reflecting rising market yields amid higher interest rates.
  • Portfolio occupancy reached 98.9% in Q2—the highest level in over a decade—and year-end occupancy guidance was raised to above 98%, while same-store rental revenue grew 2% in Q2 and 3% YTD (guidance now ~2% for 2022).
  • Q2 AFFO per share was $0.97 (up 10.2% YoY); with a well-capitalized balance sheet (net debt/EBITDAR ~5.3×) and $1.8 billion of long-term capital raised, the company reaffirmed its 2022 AFFO/share guidance of $3.84–$3.97.
  • The Bay REIT merger integration is complete with a unified ERP system live, on track to deliver $45–$55 million of annualized synergies, and Realty Income declared its 116th consecutive quarterly dividend increase and 625th monthly dividend.
AI Generated. May Contain Errors.
Earnings Conference Call
Realty Income Q2 2022
00:00 / 00:00

There are 16 speakers on the call.

Operator

Afternoon and good morning, and welcome to the Realty Income Second Quarter 2022 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Andrea Baer, Manager of Corporate Communications.

Operator

Please go ahead.

Speaker 1

Thank you all for joining us today for Realty Income Second Quarter Operating Results Conference Call. Discussing our results will be Sumit Roy, President and Chief Executive Officer and Christy Kelley, Executive Vice President, Chief Financial Officer and Treasurer. Also joining us on our call is Jonathan Palm, Senior Vice President, Corporate Finance, together with our OneTEAM leaders. During this conference call, we will make certain statements that may be considered 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.

Speaker 1

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 I will now turn the call over to our CEO, Soumit Roy.

Speaker 2

Thank you, Andrea. Welcome, everyone. Cultivating strong and enduring relationships with all our stakeholders It's foundational to the success of our business. And I'd like to thank everyone listening for your continued support. Additionally, I would like to express my appreciation to all my Realty Income colleagues who continue to make significant contributions towards our growth initiatives, While serving our clients and all stakeholders as one Realty Income team.

Speaker 2

We are pleased with the momentum across all areas of our business Amidst an uncertain macro environment, which we believe once again demonstrates the stability of our business model And its ability to thrive irrespective of the economic cycle. The strength of our global investment pipeline Has allowed us to invest over $3,200,000,000 in high quality real estate in the first half of the year, including approximately $1,700,000,000 during the Q2. Given this momentum, We are increasing our 2022 acquisitions guidance to over $6,000,000,000 On the topic of acquisitions, I'd like to mention 2 key developments We are observing in the marketplace. 1st, as demonstrated by the weighted average 5.7 percent cash cap rate, We were able to achieve on our investments in the 2nd quarter. Cap rates are moving higher in our target markets.

Speaker 2

Our 2nd quarter cap rate ticked higher compared to the 5.6% and 5.4% cap rates we achieved in the previous two quarters. The positive correlation between cap rates and interest rate is also evident in our acquisition pipeline. 2nd, as a corollary to rising debt and equity costs that have impacted much of our competition, the pipeline of acquisition As a reminder, we report our cap rates on a cash basis. On a straight line basis, we estimate our 2nd quarter cap rate to be approximately 6.2%. And generally, the difference between cash and straight line cap rates ranges Between 5070 basis points in any given period.

Speaker 2

Transaction flow remains strong with sourcing volume totaling approximately $26,000,000,000 in this quarter, Bringing year to date sourcing volume to approximately $60,000,000,000 We remain selective as we have acquired approximately 5% of sourced volume During the Q2, as a percentage of revenue, approximately 39% of acquisition volume was leased to investment grade rated clients. We remain committed to our underwriting principles of partnering with well capitalized clients who are leaders in their respective industries. Our international investment volume continues to comprise a significant percentage of our total volume, representing 41% of global volume in the 2nd quarter at a cash cap rate of approximately 5.8%. We are encouraged that our size, Scale and access to well priced capital provides us with the platform and currency to actively deploy capital as we build continued momentum heading into 23. It was also an active quarter with regard to dispositions.

Speaker 2

We sold 70 properties, Generating net sale proceeds of $150,000,000 at an unlevered IRR of approximately 9.3%. Year to date, we have sold 104 properties with net sales proceeds totaling $272,000,000 generating an unlevered IRR of approximately 9.4%. Capital recycling continues to be a value accretive activity for us and importantly, The unlevered returns we have been able to deliver speak to the attractive risk adjusted investment profile of our properties that have gone through our full investment cycle. Our diligent underwriting process, exposure to high quality credit clients and the inherent quality of our real estate Continue to deliver consistent performance. At the end of the second quarter, our occupancy was 98.9%, The highest occupancy rate we have achieved in over 10 years.

Speaker 2

Based on our current occupancy rates and client profile, We are increasing our year end 2022 occupancy guidance to over 98%. During the Q2, we re leased 193 leases And achieved a rent recapture rate of 105.6 percent, bringing our year to date recapture rate to 105.9%. At quarter end, 43.2 percent of our portfolio's annualized contractual rent was generated from investment grade rated clients. Further, our properties leased to clients on our portfolio watch list represents less than 4% of our portfolio's annualized contractual rent, which is largely consistent with the low percentages we have seen so far this year. Finally, our same store rental revenue increased 2% during the quarter and 3% year to date.

Speaker 2

With the continued strong operations performance of our portfolio, we are increasing our guidance for same store rent growth to approximately 2% for 2022. At this time, I'll pass it over to Christy, who will further discuss results from the quarter.

Speaker 3

Thank you, Sumit. During the Q2, our business generated $0.97 of AFFO per share, representing 10.2% year over year growth. The growth engine of our company revolves around accretive acquisitions. Our investment goals are supported By our well capitalized balance sheet and favorable cost of capital, which remain competitive advantages for us in the net lease industry, We finished the quarter well within our target leverage ratios with net debt to annualized adjusted EBITDAR of 5.3 times or 5.2 times on a pro form a basis, giving annualized effect to net investment activity during the quarter. It was another active quarter for us on the capital raising front as we issued approximately $1,800,000,000 of long term and permanent capital, Including nearly $1,100,000,000 of equity through our ATM program and a £600,000,000 private placement note offering which priced at a weighted average fixed interest rate of 3.22 percent with a blended tenor of 10.5 years.

Speaker 3

As a result, we finished the quarter with approximately $1,000,000,000 of commercial paper and revolver borrowings, net of cash. Our outstanding CP and revolver borrowings essentially represent our only variable rate debt exposure across a total debt principal balance Of almost $16,000,000,000 As Sumit mentioned previously, our ability to access well priced Capital is a competitive advantage, and we took steps during the quarter to further bolster this capacity. As previously announced in April this year, we recast and upsized our multi currency revolving credit facility from $3,000,000,000 to $4,250,000,000 Subsequent to quarter end, we upsized our U. S. Commercial paper program From $1,000,000,000 to $1,500,000,000 and established a euro commercial paper program with a capacity of $1,500,000,000 The combined $3,000,000,000 commercial paper programs for which our revolving credit facility serves as a liquidity backstop We'll give us the flexibility to efficiently finance our short term funding needs at materially lower rates than comparable facility borrowings.

Speaker 3

Given the momentum we continue to see in our investment activities in Europe, the establishment of a euro program was a strategic goal of ours this year and it will serve as an efficient tool for us to take advantage of the comparably lower all in commercial paper rates in the euro market. With the health of our portfolio and investment progress achieved year to date, balanced alongside the timing of We affirm our previously announced 2022 AFFO per share guidance of $3.84 to $3.97 representing nearly 9% annual growth at the midpoint. From a dividend perspective, as a monthly dividend company, consistent quarterly increases in dividend reflect The confidence we have in the cash flow generating capacity of our business. In June, we increased our dividend for the 100 and 16th time in our company's history, and last month, we declared our 6 25th consecutive common stock monthly dividend. From a sustainability perspective, further in June, we published our Green Bond Allocation Report and I am pleased to report that the net proceeds Deeds from our inaugural Green Bond offering have been fully allocated to eligible Green projects in accordance with the criteria outlined And our Green Financing Framework.

Speaker 3

From a merger perspective, lastly, I am pleased to report that we have completed The integration of our Bay Reit merger, which culminated in the conversion to a single ERP system for the combined entities during the Q2. This could not have been accomplished so seamlessly without the commitment and dedication of our talented ONE team. And finally, we remain on track to achieve the expected $45,000,000 to $55,000,000 of annualized run rate cost synergies we initially shared over a year ago when we announced the merger. And now, I would like to pass the call back to Sumit.

Speaker 2

Thank you, Christy. Coming off a record 2021 from an investment standpoint, I'm proud that our team has only accelerated the momentum this year. Most importantly, we believe the future is bright as our positioning to further gain market share in the investment arena grows. Indeed, The advantages afforded to us given our size, scale and access to well priced capital have rarely been more pronounced than they are today, and we look forward to continuing to capitalize on this in the days ahead. At this time, we can open it up for questions.

Speaker 2

Operator?

Operator

We will now begin the question and answer Our first question is from Michael Goldsmith with UBS. Please go ahead.

Speaker 4

Good afternoon. Thanks for taking my question. First question is on cap rates moving higher, The market is getting a little bit better. You have a larger acquisition team due to the VEREIT merger. How can you be a little bit more aggressive or take advantage of the improving markets just Given that combined with there are some uncertainties in kind of the borrowing markets as well.

Speaker 2

That's a good question, Michael, because there are competing variables in this market today. You're absolutely right that cap rates are moving in the right direction. They are adjusting a lot quicker than I had originally anticipated. We do have a much bigger team and with the Verite merger, some of the team members that we have Inherited, they are definitely producing and focusing on a certain area of the high real market that is Actually resulting in transactions for us. The offset to that, however, is the capital markets.

Speaker 2

Look, on a relative basis, we are doing very well. If you look at our 10 year unsecured bond spreads, They have moved, I would say, approximately 85 basis points. You look at our peers, our net lease payers with a BBB rating, it's Moved 120 to 150 basis points. If you look at our cost of equity, it is essentially unchanged from the beginning of the year. But if you look at our net lease peers, they've dropped by about 1.8 times.

Speaker 2

So those are the positive momentums, But it is true also that our cost of capital overall has also increased. And the question really is around, can we generate the right spreads to move the needle on the overall FFO And the answer is yes. But as you know, there is an adjustment period, which is why We have increased our acquisition guidance to over $6,000,000,000 from over $5,000,000,000 as a testament to what we are seeing In terms of benefits accruing to us, based on some of what I just discussed, we are starting to see a lot more transactions Coming back to us, those that we were not willing to price at the levels that the sellers were expecting when they initially brought it to us are now coming back with an adjusted cap rate, which works. It is also true that The overall team has been able to just source more and those are sort of shown in the sourcing volumes that we have Shared with you of $60,000,000,000 year to date. But with interest rate movements And more importantly, the velocity at which these interest rates have moved, the spreads continue to be right around 110, 111 basis points year to date, which is slightly below our overall average.

Speaker 2

So that's the reason why that This positive momentum is being reflected in higher acquisition volume, but not necessarily

Speaker 4

Very helpful. And then as a follow-up, European acquisitions were about 40% this quarter. And so That represents a bit of an acceleration from what we've seen. So is 40% kind of the right mix for next year Or at least the second half into next year, like how are you thinking about the U. S.

Speaker 4

Versus Europe mix going forward?

Speaker 2

Yes, Michael, it fluctuates. I mean, there have been quarters actually where the international acquisition number has been north of 50% of the overall volume. And as we start to grow into newer markets, etcetera, obviously, the total addressable market continues to increase for us. And as we become much more mature in each one of these newer markets, the sourced volume as well as which translates to closed volume Will increase. But I wouldn't go so far as to say that, at this point in time, we should be thinking anything north of That's 40% number, 41% is what we achieved in the 2nd quarter as being it should be the guiding Composition of the overall acquisition numbers going forward.

Speaker 2

There will be quarters where we'll do more just like we've done in the past, But 40% seems to be the right number.

Speaker 4

Thank you very much.

Speaker 2

Thank you, Michael.

Operator

The next question is from Nick Joseph with Citi. Please go ahead.

Speaker 5

Hi Nick. Thank you. Hi, how are you? You touched on cap rates obviously expanding a bit. Wondering if you could break that out between international versus the U.

Speaker 5

S. Where you've seen more Where you've seen more stickiness or any differences between the 2?

Speaker 2

Sure. That's a great question, Nick, and welcome back to our space. I would say that the movement in cap rates here in the U. S. Are certainly much more pronounced than what we have seen in the international markets.

Speaker 2

And it is largely a function of the Fed being a lot more aggressive than the ECB or the Bank of England have been. Having said that, we just saw an announcement earlier today that the Bank of England has moved its interest rates 50 basis points. So we do see that translating to higher cap rates in the U. K. As well as in the rest of Continental Europe.

Speaker 2

So just to quantify some of these movements, I would say that depending on the product And when I say retail, you can go from groceries, which have moved the most because they had become the most aggressive. They've moved up about 100 basis points to some of the other industries that we focus on within the retail space. I would quantify that movement as being right around 25 to 50 basis points. And you should start to see that being reflected in The subsequent quarters and the acquisition cap rates, cash cap rates that we are going to share with the market going forward. In Europe, we have also seen movement, but it hasn't been quite as pronounced, maybe 5 to 10 basis points.

Speaker 2

On the industrial side, the movement has been a bit more Visible, 25 to 50 basis points, similar to what we experienced here in the U. S. But I would say the industrial market has Continue to see an expansion on cap rates. And I would say from beginning to end, maybe circa 50 basis points of movement on average. Now obviously, there are certain markets where the movement has been a lot, lot less than that.

Speaker 2

Inland Empire Comes to mind, but the more secondary, tertiary markets you have seen a more pronounced movement and it could be even north of 50 to 75 basis.

Speaker 5

Thanks. That's very helpful. And then you mentioned deals coming back. Do those fall out of contract? Did the seller just not Pricing, what are you seeing broadly as those as you get a second crack at some of them?

Speaker 2

Yes. It's largely Buyers that rely on the debt capital markets, either the CMBS market or the bank loan market, You're in New York. You know what the money market, the big banks, the BFAs, The JP Morgan's, the Wells, I'm not going to say that they have a moratorium on new loans, but it is much more difficult

Speaker 6

for them to

Speaker 2

create new bank debt, for them to create new bank debt or increased revolvers, etcetera, for more distressed credit. So the overall debt market has sort of become a lot more expensive for some of these levered buyers and that's what we've seen Is that they are no longer being able to honor the original cap rates that transactions were being struck at. And of course, we chose not to pursue those transactions at those given pricing. And so when they do come back to us and as Long as we like the transaction, it was just a pricing discussion. We are being able to now either honor the Cap rate that we had or even expand out those cap rates to reflect current market conditions.

Speaker 2

But the fact that The surety of close has become so much more important for the sellers today is clearly prevalent in a lot of the discussions that we are having with the sellers today.

Speaker 5

Thank you. Sure.

Operator

The next question is from Connor Seversky with Berenberg. Please go ahead.

Speaker 3

Hi, Connor.

Speaker 7

Hi, Arthur. Thanks for

Speaker 8

having me on the call.

Speaker 9

I'm curious

Speaker 8

On this cap rate discussion and I appreciate your comments that you have a correlation between Rising rates and subsequent impact on cap rates, but I'm wondering if you've ever been able to establish what the lag looks Like for example, with a 25 basis point increase in rates, how long does it take for that to reflect in cap rates? And then Second to that, are you seeing that relationship accelerate given that you are seeing some of these lending partners shut down their operations?

Speaker 2

Yes, it's a great question. And unfortunately, if we were in a lab where we could control all variables that sort of drive this Correlation, it would be a lot easier of an answer to give you. Historically, when we've done these correlations, We have found that the lag to be anywhere between 9 to perhaps even as long as 12 months. I was a lot more skeptical coming into this particular situation, coming into this year and seeing the rising interest rate environment. Just Because of the sheer volume of capital that has come into our space on the institutional side, and I was a bit hesitant to Continue to say, hey, it's going to be this 9 to 12 month lag before cap rates start to reflect Private equity side as well as on the public side of the equation, the debt markets adjusted a lot faster.

Speaker 2

And therefore, the pullback From these newer buyers in our space has been a lot more acute, Which has resulted in cap rates adjusting a lot faster. I mean, we've had a rising interest rate environment now for the last 6 months and we are already starting to see cap rates adjust 25 basis points to 50 basis And like I said, in the grocery sector, we saw sale leasebacks being done in the low 4s that are now coming back And being done in the low fives to mid fives. So, it's not a constant, Connor, that I can point to, it is a reflection of the environment that you're faced with. But it's a good thing for us, truth be told, That cap rates can adjust as quickly as they have in a rising interest rate environment. I just hope that the corollary is not true.

Speaker 8

Got it. That's very interesting color. I'll leave it there. Thank you.

Operator

Thanks. The next question is from Haendel St. Juste

Speaker 2

So I

Speaker 10

guess I'm curious on Your assessment of the non Igrade portion of the market right now, curious, I understand it's not a focus of yours, but you do dabble and do have They are curious of the relative attractiveness of iGrade versus perhaps non iGrade and if there was a scenario perhaps enough

Speaker 2

Hi, Haendel. Yes, this is a narrative that continues to be out there that we are not focused Or that we are disproportionately focused on the high grade side of the equation. Just look at what we did this quarter. I mean, 62% of what we did was sub investment grade or non rated. So It is, I don't believe, true to say that all we focus on is investment grade credit and that particular product.

Speaker 2

What we have tried to share with the market clearly unsuccessfully so is that we focus on risk adjusted returns. There are points in time where the risk adjusted returns on investment grade credit is far superior to what we were Seeing on the non investment grade side and we pivot there and we try to do those transactions. And then there are other times where the exact opposite It's true. Where sub investment grade is allowing you to capture risk adjusted returns that are far superior. And so we find ourselves in that period today where we are finding very good on the non investment grade side of the equation and as such are being able to get a lot of those transactions over the finish line, I.

Speaker 2

E. 62% in the second quarter. So we are indifferent to the credit ratings. What we focus on is looking at the totality of that particular opportunity to then ascribe You know, a return profile that makes sense for the risk that we are undertaking. And that will continue to vary.

Speaker 2

We don't target investment grade. Investment grade tends to be a byproduct of the underwriting. So hopefully that clarifies The question you asked.

Speaker 10

Sure, sure. Certainly appreciate the color and the perspective. Any update with ENCORE still on track to close, I believe, in Q4. How is the regulatory and licensing coming along?

Speaker 2

Still on track. We are quite optimistic. We've continued to stay very close to the MGC. We are working very closely with them. So we are very optimistic That it will close by the end of this year in Q4.

Speaker 4

Thank you. Sure.

Operator

The next question is from Brad Heffern with RBC Capital Markets. Please go ahead.

Speaker 3

Hey, everyone. Hi, Brad.

Speaker 11

Hi, Christy.

Speaker 7

Hi. One for you, I guess. On the new guidance, Can you just talk about the moving pieces that kept the AFFO per share number unchanged despite the higher acquisition total? I know Sumit said, potentially tighter spreads versus The cost of capital, but I'm curious if there was an FX impact or interest expense impact or anything else?

Speaker 3

Yes. I think, Brad, just to start off, Sumit had started to touch on this in terms of some of the moving pieces, Given the fact that we had increased our acquisition volume to over $6,000,000,000 but kept as you observed our AFFO per share guidance The same and reaffirmed it. And there are some factors there in terms of, first, the volatility in the Capital Markets, as we've discussed, the overall rate hikes and the magnitude of those hikes And any future actions that may be taken, both in terms of the European and U. S. Environment.

Speaker 3

We also to the point that you were making, we do actually hedge From the perspective of FX to protect our international income as well as we've got hedges In place to lower our effective interest rate, and we will touch on that a bit more in a second. But the other thing too is that just the general Timing of the investment volume, the team is just doing a great job. We've got really strong momentum, as Sumit's discussed, in the market. And the acquisitions that we closed from now towards the end of the year, while are attractive, are really going It'd be setting us up nicely for 2023. So the timing of that isn't as beneficial For the year in AFFO as it will be for the full year impact next year.

Speaker 3

And I think to the upside, we still have some clients on cash accounting that have just started under their deferral arrangement. And so we'll be monitoring them for continued consistent payment performance and make the appropriate Calls in alignment with our policy and guidelines as to when we may be taking them off of cash accounting. But I'd like to turn it over to Jonathan to talk a little bit more specifically about hedging and the impact.

Speaker 5

Thanks, Christy.

Speaker 9

Yes, Brett, you've seen us obviously issue a lot of local currency debt in the sterling market. That's intentional, obviously, much lower all in rates there, but certainly from a natural hedge perspective, having interest expense Denominated in the same currency where we're now getting rent limits the exposure that we have to FX volatility. And then we have a cleanup methodology where we hedge a portion of AFFO that is unhedged. And From that dynamic, we feel like we've mitigated the range of outcomes upside and downside, but there is still some unhedged exposure about 60 And our foreign denominated AFFO is unhedged. So for every 10% move in the dollar, for instance, you're looking at maybe a penny and a half Volatility on an annualized basis.

Speaker 9

So we're not completely hedged, which can lead to upside if we see some mean reversion here in the dollar, But just a little bit of conservatism that we're taking here sitting here in August.

Speaker 7

Okay. I appreciate all the color. And then Sumit, some of your peers this quarter have talked about portfolios trading at a discount To single assets, is that something that you've seen and are you interested potentially in pursuing more portfolio deals?

Speaker 2

No more than in the past, Brad. Portfolio deals generally do tend to trade at a discount, especially In times like this when the cost of capital have gone up and a lot of these potential buyers of big portfolios are sort of sitting on the sidelines. So this is essentially reverted back to where it was, where we would get a discount on portfolio transactions. And so if we look at our volume today, About 62% of what we did were portfolio transactions. So That actually accrues to our benefit, Brad, and we are certainly seeing exactly the same scenario as some of our peers have commented.

Speaker 7

Okay. Thank you.

Operator

Sure. The next question is from Wes Golladay with Baird. Please go ahead.

Speaker 3

Hi, Rob.

Speaker 6

Hi, everyone. Hey, there. I got a question also maybe on the FX, more so on the future hedging, I guess. As you buy more properties overseas, would you do more, I guess, CP issuance tip for the hedging? And could we see the U.

Speaker 6

S. Issuance of CP maybe go down to 0 and then using the full capacity overseas?

Speaker 9

Hey, Wes, it's Jonathan. I'll take that one. You may have seen our euro commercial paper program establishment recently, dollars 1,500,000,000 Equivalent together with the upsizing of our U. S. Dollar commercial paper program.

Speaker 9

Focusing on the euro CP side, we absolutely intend to utilize that To the extent that we have a use of euro currency, right now, obviously, interest rates are Much more comparatively, we could probably issue 1 year euro CPA in the 25 basis point context and that compares to revolver borrowings that are 75 basis points or so. So certainly having a liability and very cheap liability at that The nominated euros will be additive on all fronts, limiting the amount of derivatives that we have to engage with to hedge our exposure And lowering the all in interest rate that we have to pay on euro borrowings.

Speaker 6

Got it. And then I wanted to get back to that comment on oh, sorry, go ahead.

Speaker 2

Yes. Wes, having said all of that, we will be leaning towards permanently financing our acquisitions As soon as possible. I mean, this is really a mechanism for us to provide the surety to the market And take advantage of our A minus A3 rating. But this will continue to not dominate our overall debt profile. If you look at what our outstandings are today, it's about 7% and that is how you should think about us running our business going forward.

Speaker 6

Got it. Then I want to go back to that comment about widening cap rates. I'm just curious if you're seeing any difference between So leasebacks, marketed assets, developer takeouts, any of your channels that you look at?

Speaker 2

Yes, it's not a function of the channel. I would say, Wes, it is much more a function of the overall markets. If you're starting to see cap rates move In portfolio transactions, whether the portfolio comes from another seller or from a sale leaseback avenue, It's going to be reflective of markets. Does relationship play a hand? Sure, it does.

Speaker 2

But those are 5 to 10 to maybe 15 basis At best, but it is really the market that dictates what those cap rates are going to be, not so much the channels.

Speaker 6

Great. Thanks a lot.

Speaker 2

Thank you.

Operator

The next question is from Joshua Dennerlein with Bank of America. Please go ahead.

Speaker 3

Hi, Josh.

Speaker 11

Hey, Christy. Hey, guys.

Speaker 5

So now that you've

Speaker 12

kind of completed the integration of the Berry merger, How are you guys thinking about additional M and A?

Speaker 2

Josh, you won't let us breathe, will you?

Speaker 11

You guys got to work hard. I mean,

Speaker 12

especially Jonathan, he's got to work extra hard.

Speaker 2

That's true. That's true. Josh, we've always said that look, as far as M and A is concerned, we We are always open for opportunities, but it is not easy to facilitate an M and A trade. You need willing partners, you need the market environment to be conducive, you need to be able to look at the other Before you can help facilitate an M and A trade. But having said all of that, and this is very consistent with what we've said in the past, We are always looking and if the right opportunity presents itself, we are not going to shy away from it.

Speaker 2

So We've shown that we can do it. We've done it a couple of times now. And we'll keep looking And keep working hard like you said, Josh.

Speaker 11

And then I think you mentioned grocery anchors. It sounded like the cap rates moved like 100 basis points higher. Were there any other asset classes or property types where you're seeing that kind of magnitude of a move?

Speaker 2

Yes, the industrial, I would say, not across the board, but some industrial, the movement has been quite pronounced as well. I Don't know if it's a 100 basis points, but it wouldn't be far to say 50 to 75 basis points. I just felt like that the grocery market Decelerated, I. E, the compression on the cap rates was so immediate from where we used to buy grocery here in the U. S.

Speaker 2

In the high fives, this was the best in class grocery. It accelerated down to the low fours and this was Absolutely a testament to the amount of capital that had come into our space and the cost of debt available, that allowed these buyers To essentially hit the yield that they've required on a cash on cash basis. And the unwinding was as quick, partially driven by what the Fed chose to do, partially driven by how that translated into the debt market And then the withdrawal of some of this capital that relied on the debt markets. So I think that Phenomena is very unique to that particular sector of retail. And we didn't see that compression In any other sector that I can think of.

Speaker 11

Interesting. Thanks, guys.

Speaker 2

Thank you.

Operator

The next question is from Ronald Kamdem with Morgan Stanley. Please go ahead.

Speaker 5

Hey, just a couple

Speaker 13

of quick ones. Staying on maybe not Hey, how are you? Just staying on the theme of large acquisitions, maybe M and A, but just even just bigger portfolio deals. I remember One of the benefits of sort of having a larger platform is being able to do these larger sale leasebacks. Just any update on how that pipeline is building And when can we see sort of more of those deals come through?

Speaker 2

Yes, Ron. I'll tell you the pipelines is big and we are in discussions On fairly sizable opportunities. Again, similar to my comments with regards to M and A, I think It's difficult. Sellers are still a bit anchored on the past in terms of where the market was literally 5 to 6 months ago And their willingness to sort of recognize the current state of affairs is what's going to dictate as to whether these conversations and these Pipeline opportunities translate to under contract opportunities. But I can tell you, Ron, that our pipeline has never looked stronger.

Speaker 2

And a lot of that makeup is from Bigger portfolio transactions, and so we are hopeful that a few of these will get over the finish line. And if it does, you'll be the first to know.

Speaker 13

Great. And if I could just ask one quick one on the guidance. Just what's the assumption for and sorry if you covered this, sorry, but what's Assumption for bad debt and did that change at all because it seems like that's been pretty low?

Speaker 2

Yes. Jonathan or Kristi, you should take that.

Speaker 3

Yes. In terms of in terms run of bad debt, yes, there There was no specific change as it relates to bad debt. And in terms of The impact, for example, we've talked a lot about the clients that we still have on cash accounting and the fact that The deferral arrangements for a good approximately handful of those that were primarily impacted During COVID in the theater and health and fitness space, their deferral arrangements started in July. And so we will be looking at Their continued strong collections performance and make the appropriate calls in relation to our Policies and things as we continue through this year and determine if we will be taking Any of those clients off of cash accounting. And some of that impact, Ron, is also One of the variables that we factored in as it relates to the upper end of our guidance.

Speaker 13

Thank you.

Speaker 9

Ron, I would just add, in terms of the remainder of the year guidance, We're really looking at more of a normalized assumption. So first half of the year, we've actually benefited from paybacks on deferral That have actually resulted in flat or even negative bad debt expense. So a little bit of conservatism in the back half of the year just given the

Speaker 13

Thank you.

Operator

The next question is from John Massocca with Ladenburg Thalmann. Please go ahead.

Speaker 11

Good afternoon.

Speaker 3

Hi, John.

Speaker 11

How's it going? So as we think about the competitive environment You faced in the Europe versus the U. S. I mean, how sensitive are your European competitors to rising rates?

Speaker 5

And I

Speaker 11

guess if we can see continued upward pressure on UK and EU rates, could it push certain competitors out of the market kind of similar to what you've seen in the U. S. Year to date. Absolutely.

Speaker 2

Not trying to be flippant here, John, but that is exactly what we expect to see happen. I think I mentioned that the BFA Has just raised their interest rates by 50 basis points to 1.75. We should start to see the cap rates adjust, but A lot of the levered buyers and those happen to be quite a few there, will start to fall by the wayside. We've already seen that on a few transactions that we've been pursuing in the international markets. And again, this certainty of close is what gets amplified at To close on especially large transactions.

Speaker 2

And so I expect What we are seeing happen here in the U. S, a similar storyline to play out in the international markets. And given that the level of competition that we face there, John, is actually a lot less. We expect those advantages to be even more enhanced in quarters to come.

Speaker 11

And I guess maybe if we think back to kind of 3Q and 4Q of last How important was the non public levered buyer in the European markets versus the U. S? Is it kind of a bigger portion of the competitive set or is it Equal or less?

Speaker 2

Yes, that's very difficult to quantify. But if I had to guess, I would say that There are more of the buyers in Europe that rely on the debt markets. And what makes it challenging is that the debt markets are Potentially not quite as mature as we have here in the U. S, circa fewer people that we were competing with For the kind of product that we've been pursuing, and this is consistent with one of our strategic reasons to Expand into Europe is the lack of similar kinds of competition that we see here in the U. S.

Speaker 2

And more of an amplification of our inherent advantages in that particular market. And we are certainly starting to see that more so recently.

Speaker 11

Okay. And I know it's a relatively recent phenomenon, but As you think about tenant credit, both with acquisitions and the in place portfolio, how are you thinking about sellers of kind of Hard goods versus more services oriented tenants, given some of the recent shifts in consumer demand?

Speaker 2

Yes, it does depend on the type of hard goods. I will tell you, Walmart just came out with another announcement today. They're getting pressured, but do I see Walmart struggling to pay their rent? I don't. Do I see now if you were to look at Categories, do I see apparel companies suffering a little bit more, especially if discretionary income continues to get pressured?

Speaker 2

Absolutely. Do I see quick service restaurants suffering the same? I don't. We saw this play out in the great financial crisis where some of the service oriented businesses actually thrived. The movie theater business did very well.

Speaker 2

The Health and fitness business did quite well, because especially the lower cost health and fitness concepts, because they tend To attract the more value sensitive consumer base at times where alternatives Have become a lot more expensive. I do expect casual dining to feel a little bit more of the pressure. But again, the concepts are important, who the operator is, is important, their balance sheet strength, their ability to Take lessons learned from the pandemic where there were a lot more click and collects and delivery that They were able to pivot to in terms of their business model. Those I think will hold them in good stead for the ones that survived and were able to Specific to the particular vertical and the environment we find ourselves in.

Speaker 11

Very helpful color. That's it for me. Thank you very much.

Speaker 2

Thanks, Sean.

Operator

The next question is from Chris Lucas with Capital One. Please go ahead.

Speaker 1

Hi there, Chris.

Speaker 14

Good afternoon. Hi, Christy. Good afternoon, everybody. Just a follow-up question on the commercial paper program. I guess, I'm just thinking about it.

Speaker 14

So you've got $1,500,000,000 denominated and $1,500,000,000 of euro denominated. Was there a specific reason why euro denominated rather than pound denominated related to efficiency, depth of market, future uses? Just Trying to understand why euro and not pound?

Speaker 9

Sure, Chris. Hey, Chris. It's Jonathan. There's a Nuance in the commercial paper market, the sterling market is really not that deep. So you don't really see a lot of standalone sterling programs.

Speaker 9

The Euro commercial paper program does give us the flexibility to issue in Sterling. And so to the extent there is demand In that market, we'll be able to tap into it. But by and large, this market is dominated by dollars and euros.

Speaker 14

Okay, great. Thank you for that. And then, Seema, just kind of taking a step back, sort of talk a little bit around the foreign exchange issue that's This year, we've seen a pretty meaningful move in both the in terms of the dollar appreciation relative to the euro and the pound. And if you kind of look Historically back at this other than really like a week during COVID in March of 'twenty, you have to go all the way back The Reagan administration defined sort of this relative value on both the pound and on the well, it's only not the euro going back that far, In terms of the dollar strength, so my question is, does that impact at all your view about where to allocate capital At this point or are you completely agnostic to the exchange rate?

Speaker 2

It would be unfair to say, Chris, that we are agnostic to the exchange rate. Obviously, this is something that we have acute focus on. Like we said, we are not 100% hedged. That wouldn't be economically prudent to do so. We are about 40% hedged on our income stream.

Speaker 2

And we have instituted strategies to sort of mitigate fluctuations in the foreign exchange market. Having said all of that, we did exactly the same analysis, Chris, to figure out at which point in time Were these exchange rates at current levels and concluded the same that look, Again, I might look foolish in 3 months from now, but this looks like the low point in terms of foreign Change between the GBP and the U. S. And the euro in the U. S.

Speaker 2

And you're starting to See, with increases in interest rates by the Bank of England, similar to the ECB, you're starting to see that correct itself and Start to revert a little bit more to the mean. So that could potentially act as a tailwind, but not knowing and Not trying to take a forecast on where these things are going to play out. That's the reason one of the main reasons why we Kept our range exactly the same, but we believe that we are very well situated currently. Ultimately, this is a long game. And What we want is to let the product and the acquisition opportunities dictate with an eye on the exchange rate, Dictate how we build out our portfolio.

Speaker 2

So totally not fair to say we would be agnostic, But it is something we keep in mind, but doesn't necessarily drive our strategy in its entirety.

Operator

The next question is from Harsh Hamnani with Green Street. Please go ahead.

Speaker 12

Hey, Christy. Quick one for me. When you think about the investments in Europe, what percentage of them Are sale leaseback originations versus acquisitions of existing leases? And how does that compare to your investments in the U. S?

Speaker 2

I don't think that there is a major difference between the If you look at what we did on the sale leaseback side, Harsh, it was right around 28% year to date. And we've had quarters where it's been as high as 75%, and we've had quarters where it's been as low as 20%. And so it really is a function of what's available, when is it closing in a given quarter, etcetera, that dictates the sale leaseback piece. Having said that, I think when we do decide to pursue sale leasebacks in a meaningful way, It is possible that some of those transactions would be much larger in size. For instance, if you think about our inaugural transaction that we did when we first went into the U.

Speaker 2

K, it was a sale leaseback that we did with Sainsbury's. That was a $500,000,000 If you think about the gaming industry and the sale leaseback we've done with them, it's going to dominate that particular quarter Because it's a $1,700,000,000 transaction. And we see similar types of opportunities Where when and if those close in a given quarter, it's going to dominate that particular quarter. And I don't think it's unique just to the U. S.

Speaker 2

I think it will be consistent between the U. S. And the international markets.

Speaker 12

Okay. Thank you.

Speaker 2

Thank you.

Operator

The next question is from Linda Tsai with Jefferies. Please go ahead.

Speaker 3

Hi. Hi, Linda.

Speaker 15

Hi, Christy. In terms of the 2% growth in same store revenue, I saw health and fitness And restaurants and materially theaters contributed to the positive change in the 2nd quarter same store. When did the strong comp start to normalize? And is that partly dependent on cash basis payback?

Speaker 2

It is. It's when we Start to sort of take a lot of these clients off of the cash basis and get them back on accrual basis. You're Same store rental growth that you're seeing is essentially a byproduct of moving some of these cash accounts back to accrual account. And once all of this normalizes, you should expect us to be back in that 1% to 1.5% Same store growth, but right now it's this period where we are now starting to recognize and move some of these clients And case in point AMC, back to accrual accounting and that's disproportionately impacting The growth rate in a very favorable way.

Speaker 15

That's helpful. And then I think previously you talked about putting some money into vacant Properties to redevelop to help re leasing prospects. Is this something you're still pursuing?

Speaker 2

Very much so, And I think that is being captured in some of our releasing spreads that we've that I'm so proud of the asset management team, One of the highest recapture percentages that we had was taking a quick service concept and Converting it into an alternative retail concept largely driven by a predictive analytics tool, saying that the best and use for this You can track some of that, but that is absolutely very much a focus of ours, Linda, and we hope that that will continue to be Become a bigger and bigger portion of the value driver of our growth going forward.

Speaker 1

Thank you.

Speaker 2

Thank you.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Sumit Roy for any closing remarks.

Speaker 2

Thank you all for joining us today. I hope everyone enjoys the rest of the summer and we look forward to speaking with you again soon. Thank you.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Powered by Quartr