Realty Income Corporation (NYSE:O) Q1 2024 Earnings Call Transcript May 7, 2024
Realty Income Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, and welcome to the Realty Income Q1 2024 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would like now to turn the conference over to Mr. Steve Bakke, Senior Vice President of Corporate Finance. Please go ahead.
Steve Bakke: Thank you all for joining us today for Realty Income’s first quarter operating results conference call. Discussing our results will be Sumit Roy, President and Chief Executive Officer; and Jonathan Pong, Chief Financial Officer and Treasurer. During this conference call, we will make 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. You’ll 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 reenter the queue. I will now turn the call over to our CEO, Sumit Roy.
Sumit Roy: Thank you, Steve. Welcome, everyone. Our results for the start of 2024 illustrate our focus on thoughtful, disciplined growth and continue to demonstrate the consistency of our global operating and acquisition platform. We believe our value proposition to investors is a simple one. Our demonstrated ability to generate consistent positive operational returns regardless of market volatility and economic environment. Our projected 2024 operational return profile of approximately 10%, which comprises an anticipated dividend yield close to 6% and AFFO per share growth of approximately 4.3%, assuming the midpoint of guidance is a validation of our value proposition. To summarize the results from the quarter, we would highlight several key takeaways.
First, diversification. Diversification by geography, asset types and client relationships. We believe our business model is unique in the real estate sector as we have optionality to grow in different regions with investments in a multitude of real estate products where we see superior risk-adjusted returns. During the first quarter, we invested $598 million at an initial weighted average cash yield of 7.8% across three property types: retail, industrial and data centers. Over half of this volume representing approximately $323 million was invested in Europe and the U.K. at an 8.2% initial weighted average cash yield. Investment volume in the U.S. was modest during the quarter. Of the $275 million of U.S. volume, which was invested at a 7.3% initial weighted average cash yield all but $16 million was invested in previously committed development takeouts.
This quarter’s bias towards international volume is a testament to the diversity of geographies we consider to allocate capital. To further elaborate, our investment volume during the quarter consisted of 87 discrete transactions with three transactions over $50 million, which speaks to the breadth of our platform. Our ultimate focus with any growth vertical or new region is to serve as a real estate partner to the world’s leading companies and to ensure the investment outcome matches the consistent risk return profile of our investments, which have proven resilient over almost five decades as an operating company and three decades as a public company. Second, the health of our portfolio remains solid across all key operational metrics. We finished the quarter with occupancy of 98.6% consistent with the prior quarter and our projections.
And we delivered another strong leasing quarter with rent recapture of 104.3% on the 198 leases that we renewed or re-leased during the quarter. At quarter end, our list of tenants on the credit watch list comprise approximately 5.2% of total portfolio annualized rent, which is in line with our historical average and with no individual client representing more than 1% of our total portfolio annualized rent. Consequently, we would highlight the diversification of our portfolio, which today consists of over 1,500 clients in all 50 states, the UK and six other countries in Western Europe, all of which helps insulate us from potential disruptive interest rate and credit events that could impact the durability of our cash flow. Finally, our balance sheet and access to capital continues to represent a major competitive advantage and affords us significant flexibility to fund our business without the need for external capital.
After the Spirit merger closed in January, our annualized free cash flow available for investments is approximately $825 million. This provides us significant organic investment capacity to finance our growth plans without being required to tap into the debt or equity markets to meet current investment guidance. I would also note this also excludes any additional capacity generated by our disposition program, which I will discuss later. In spite of volatility in the capital markets, we posted a nominal first year investment spread of over 340 basis points in the first quarter, which is well above our historical spread of around 150 basis points. The primary driver of these outside spreads is the significant portion of investment volume funded to free cash flow, which by virtue of being a non-diluted source of capital, meaningfully reduces our nominal first year cost of capital.
To be clear, our investment decisions remain based on our long-term weighted average cost of capital, which considers only our cost of stock for equity and long-term 10-year unsecured debt. This establishes the minimum return hurdle we seek to exceed across our aggregate investment activity. In all cases, our long-term WACC has exceeded our nominal first year cost of capital with respect to our transactions. This long-term oriented underwriting model is what drives our focus on acquiring high-quality real estate, leased to solid operators who are leaders in their respective industries, because we believe these opportunities have significantly lower residual risk — value risk. In addition, to reach our longer-term growth hurdle rates, we are increasingly prioritizing meaningful contractual rent escalators in our leases with conservative rent coverage metrics that we believe will be even more resilient through a variety of economic cycles.
In summary, activity in the transaction market remains uneven. Many potential sellers of real estate remain sidelined, given this uncertain interest rate environment, which is amplified by mixed inflation related data over the last six months. Sellers remain reluctant to transact and the breadth and depth of domestic investment opportunities have compressed as a result. However, as experienced in prior cycles, we remain optimistic that the market will provide more opportunities in the second half of the year as the economic outlook becomes clearer. Turning to portfolio operations. As previously mentioned, our recapture rate was 104.3%, contributing to same-store rent growth of 0.8% in the first quarter. Excluding the negative impact from our Sinovel theater portfolio, following the lease amendments finalized late last year, our same-store portfolio was up 1.4%, largely in line with the contractual rent growth embedded in our portfolio.
One of our competitive advantages in the marketplace is our asset management and real estate operations functions, consisting of over 80 individuals who we believe are among the most talented in the industry. Since becoming a public company in 1994, we have now resolved over 6,000 lease expirations at a blended rent recapture rate of 102.5%, which is a testament to our acquisition underwriting, quality of our real estate and the scale of our asset management and real estate operations teams. During the quarter, we sold 46 properties for total net proceeds of $95.6 million. Our recycling efforts are a function of a more active investment management initiative. Our active decision-making on dispositions is supported by our proprietary predictive analytics platform.
In recent years, we have harnessed the collective contributions of our predictive analytics team, the credit underwriting group, and the fundamental input from our asset management group to inform our acquisition strategy. We believe the combined benefits of these three groups provide us a significant differentiation in the industry as a result of the quantum of data we have gathered across our portfolio over our long operational history. So now in addition to our acquisition program, we are using the data to more proactively manage the portfolio and guide our active disposition program. I will now turn it over to Jonathan, who will add further color to the quarter.
Jonathan Pong: Thank you, Sumit. It’s been a quiet start to the year on the capital markets front, following our January US dollar bond offering, which raised $1.25 billion in gross proceeds at a blended yield to maturity of approximately 5.14%. As introduced in our prior earnings call, our financing strategy for 2024 does not require incremental capital to finance our growth and acquisition needs. This continues to be the case at our current investment guidance. To that end, we had another quarter with a net debt and preferred equity, annualized pro forma adjusted EBITDA ratio of 5.5 times, that’s in line with our target ratio. During the quarter, we settled approximately $550 million of equity previously raised through our ATM program, and which was outstanding on a forward basis.
This leaves us with approximately $63 million of outstanding equity available for future settlements. And when combined with approximately $825 million of annualized free cash flow available to us following the Spirit merger, and the disposition program that Sumit referenced, our $2 billion investment guidance for the year is one, we believe can be funded without having to tap the markets. Our debt maturity schedule for the remainder of the year is modest, with approximately $469 million of remaining maturities, excluding $342 million of short-term commercial paper and revolver borrowings and of cash. As always, we look to maintain significant financial flexibility to fund known and identified liquidity and with approximately $4 billion of total liquidity available to us and minimal variability debt exposure on the balance sheet, we believe we can refinance these maturities while still retaining significant liquidity headroom and keeping ydebt exposure well below 10% of our debt capital stack through the balance of the year.
With that, I’ll turn it back over to Sumit for closing remarks.
Sumit Roy: Thank you, Jonathan. In summary, the year is off to a solid start that is in line with expectations. Our earnings growth profile for the balance of the year remains consistent with our outlook and earnings guidance we gave in February. The tempered pace of activity in the first quarter reflects our long-standing capital allocation discipline, and we will remain selective as cap rates adjust to the current rate environment. In the meantime, the levers we can exercise from an internal funding standpoint, in particular, free cash flow and capital recycling, allow us to continue investing at spreads well over 200 basis points on a leverage-neutral basis. Our approximately 4% AFFO per share projected growth rate, paired with our estimated annualized dividend yield of approximately 6% is why we believe our platform offers one of the most compelling investment opportunities in the S&P 500. With that, I would like to open it up for questions.
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