Realty Income Corporation

Good day and welcome to the Realty Income Third Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Kelsey Mueller, Vice President, Investor Relations. Please go ahead.

Thank you all for joining us today for Realty Income's third quarter operating results conference call. Discussing our results will be Sue McRoy, 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. 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.

Thank you, Kelsey. Welcome, everyone. Realty Income's third quarter results highlight our continued momentum, disciplined execution, and the benefits of our global investment and operating platform. Our value proposition to investors is simple, a real estate partner to the world's leading companies. We've created a defensive and diversified real estate portfolio consisting of top-tier clients to drive stable and predictable cash flow. As a result, we've delivered positive total operational returns each year since becoming a public company 30 years ago, successfully navigating a variety of economic environments. Importantly, as we move through an improving external backdrop helped by a recent rate cut in the U.S., we've started to see a more attractive transaction landscape. Given this, we are pleased to increase our 2024 investment volume guidance to approximately $3.5 billion, underpinned by strong investment activity year-to-date, as well as a robust pipeline for the fourth quarter. Concurrently, we are raising the low end of our AFFO per share guidance for the year to a range of $4.17 to $4.21. Despite some recent volatility driven by exogenous factors, we remain confident in our strategic vision and the opportunity ahead. Our investment strategy offers significant opportunities for growth across multiple verticals, including our core of retail and industrial and newer verticals, such as data centers and gaming. At the same time, we are making progress towards the establishment of a private capital fund, which I'll touch on later in this call. Turning to the details of the third quarter, we delivered AFFO per share of $1.05, representing a 2.9% growth compared to last year. We invested $740 million into high quality opportunities at a blended 7.4% initial cash yield or a 7.8% straight line yield, assuming CPI growth of 2%. Of this, $378 million of volume was invested in the U.S. at a 7.4% initial cash yield, with a balance of $362 million invested in Europe at a 7.3% initial cash yield. We've seen meaningful improvements in both the U.S. and Europe. Our international markets continue to contribute a greater share of volume relative to prior years with healthy investment activity year-to-date, exemplifying the benefits we achieve by cultivating multiple avenues for growth. In total, we completed 70 discrete transactions, including four transactions over $50 million, which represented nearly 60% of our investment volume, highlighting the breadth of our platform. As I noted, the momentum we are seeing in the transaction market supports increase to this year's investment volume guidance to $3.5 billion. In the third quarter, our organic acquisition activity, which excludes credit investments as well as development spending largely negotiated in prior quarters, totaled $594 million, or more than double the second quarter's volume. We expect further momentum through the balance of the year with an implied fourth quarter outlook of approximately $1.3 billion in investments, which is fully funded as we are vigilantly focused on deploying capital into high-quality opportunities that meet our risk-adjusted return requirements. Capital deployed in the third quarter yielded an investment spread of 243 basis points above our historical average spread of 150 basis points. This spread was supported by $165 million of adjusted free cash flow available after dividend payments to fund investments. These spreads are based on our short-term nominal cost of capital that measures the year one dilution from utilizing external capital and excess free cash flow on a leverage neutral basis to fund our investment volume. As a reminder, our ultimate investment decisions are based on our long-term weighted average cost of capital which burdens every dollar of equity with the same cost of equity. Underpinning our increased investment activity, the external capital improved by approximately 65 basis points in the third quarter. This compares to the decline in our weighted average initial cash yields of approximately 50 basis points during the quarter. Turning to portfolio operations, We've created a diversified portfolio of more than 15,400 properties with high-quality clients that have proven resilient through various economic cycles and continue to deliver stable returns. In addition, our vast data availability, proprietary predictive analytic tools, and insights of our asset management and research teams enhance our ability to anticipate future trends. We finished the quarter with 98.7% occupancy, a 10 basis point decrease from the prior quarter. Our rent recapture rate on the 170 leases we renewed was 105%, totaling approximately $38 million in new annualized cash rent, thanks to the diligent efforts of our team. Separately, we are continuing to lean into dispositions as an additional source of capital. In the third quarter, we sold 92 properties for total net proceeds of $249 million, of which $87 million was related to vacant properties. This brings our year-to-date total to $451 million. For the year, we now expect proceeds of $550 million to $600 million on asset sales. With that, I'd like to turn it over to Jonathan to discuss our third quarter financial results in more detail.

Thank you, Sumit. We are pleased to deliver another strong quarter while increasing our investment and AFFO guidance for the year, reflecting continued momentum. Consistent with our investment strategy, we remain disciplined in our balance sheet management. Our strong balance sheet, underscored by A3 A-minus credit ratings and deep access to capital globally, continue to represent significant competitive advantages, fueling the opportunity to grow earnings through multiple channels. Our leverage, as measured by net debt to annualize pro forma adjusted EBITDA, was a healthy 5.4 times well within our target ratio, or 5.2 times including $969 million of unsettled forward equity outstanding as of today. Our fixed charge coverage ratio of 4.6 times remains in line with the 4.5 to 4.7x range. We have delivered consistently over the last seven quarters. A focus on de-risking our future funding needs was a catalyst behind our two bond offerings during the third quarter, which consisted of a $500 million 30-year U.S. dollar bond offering and an effective semi-annual yield to maturity of 5.49%, and a dual tranche sterling bond offering that raised 700 million pounds at a weighted average tenor of 11.1 years and a weighted average annual yield to maturity of 5.4%. These offerings illustrate the diversity of debt products available to us and the intentionality of our capital diversification philosophies. Our 30-year offering was our first 30-year issuance since 2017, and our public sterling offering was our fifth non-U.S. public bond offering in approximately three years, bringing our foreign-denominated outstanding unsecured debt to over $8 billion. We are grateful for the loyal support we have received from the fixed-income community as we continue to expand our credit presence globally. At quarter end, we held $5.2 billion of liquidity, including unsettled forward equity. In addition to retaining almost full capacity net of cash available on our $4.25 billion revolving credit facility, only 3.4% of our outstanding debt at the end of the quarter was variable rate in nature, illustrating the financing flexibility we have heading into the end of the year. Access to capital is paramount to the success of our company, and our portfolio size, scale, diversification, and our trading liquidity in the public markets have consistently afforded us well-priced capital to grow through large-scale, high-quality investment opportunities. With that said, we strive to demonstrate a proactive, forward-looking mindset as we plan, position, and evolve our financing strategy for future growth. Over the last few years, we have evaluated additional sources of equity capital beyond the public markets and have recently begun, in earnest, to build a private capital infrastructure that we believe, over time, will leverage our strengths and expand the breadth of our capital allocation opportunities globally. I would like to hand it back to Sumit to provide additional color.

Sumit. Thank you, Jonathan. As we mentioned last year, A natural step in our evolution is to diversify and enlarge our access to equity capital through private markets. We see multiple strategic benefits of entering the private capital business. First, the amount of equity available from private sources far exceeds that which is available through the public markets we have traditionally accessed. The size of the U.S. private real estate market is approximately $18.8 trillion, ten times larger than the $1.9 trillion of assets owned by public REITs. Thus, private capital controls more than 90% of the U.S. commercial real estate market based on research from the National Association of Real Estate Investment Trusts. Creation of a private capital investment platform is expected to provide us with access to a deep pool of institutional capital from investors who may otherwise lack a mandate or ability to invest in real estate security. Second, access to the alternative source of equity with generally less pricing volatility will give us the opportunity to accelerate the monetization of the scalable and proven investment and operating platform we have built, in turn supporting our ability to continue delivering value to shareholders. Third, a powerful element of the fund management strategy is the incremental capital light fee earnings it's anticipated to offer. Base management income earned by managing third party capital represents a source of recurring and potentially high growth revenue, which we observe as receiving a premium multiple from the investment community. The vast majority of fees earned would be recurring in nature and generated through open-end perpetual life funds rather than performance-based or transaction-oriented fees. Fourth, the scalability of our differentiated business model will allow us to advance this initiative with limited incremental investments. while leveraging the collective talent and experience of our top tier team and platform. We have a long history of underwriting, operating, and maximizing the value of our real estate holdings, dating back to our founding in 1969. Leveraging that history, we have harnessed an impressive quantum of property level data to develop our proprietary predictive analytics model to support decision making. With additional size and scale, These data-driven insights will become increasingly robust and accurate. Together with the expertise of our team, we believe we provide a compelling co-investing platform for investors. Finally, we believe private capital will enable us to source, acquire, and manage a large percentage of available market opportunities that we currently acquire for the public vehicle. Overall, our intent is to create and operate an evergreen open-end fund that will manage private capital on behalf of institutional investors such as pension funds, sovereign wealth funds, endowments, foundations, and large insurance companies. To be clear, this structure will be distinct from a typical private equity style closed-end fund that may have a fixed duration or a narrower opportunity set. Importantly, this fund will be designated to target institutional investors. It will not be structured as a non-traded REIT, and we do not intend to market to high net worth or retail investors. Our fund business is expected to follow the same balance sheet and prudent leverage philosophy that Realty Income ascribes today. We do not anticipate an adverse impact on our balance sheet strength or credit ratings. Rather, it will enhance our financial flexibility. Realty income intends to be a meaningful co-invest in the fund while receiving management and potentially incentive fees generated by operation of the fund. These additional earnings would bolster realty incomes return on investment while ensuring incentives between public and private investors are aligned. This approach also reinforces our commitment to transparency and shared objectives. In summary, We believe this private capital platform will be complementary and additive to our existing business. We intend to take a thoughtful approach to allocating investment opportunities between Realty Income and the fund to maximize returns for our public shareholders, benefiting both our shareholders and private investors. We expect this initiative to enhance our ability to grow our earnings and dividends, expand our addressable market for investments, and reduce our reliance on public equity across market cycles when strategically advantageous. We look forward to sharing more information as we progress on launching the fund. In closing, our year-to-date performance has exceeded our expectations propelled by momentum on the investment front and supported by the stability of our portfolio consisting of leading clients across the globe. Looking forward, I'm optimistic about the multiple verticals for growth we have cultivated for capital deployment. Importantly, pairing these growth verticals with alternative sources of capital will further accelerate the maturation of our platform. I would now like to open it up for questions. Operator?

Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Today's first question comes from John Kilchowski with Wells Fargo. Please go ahead.

Thank you. Maybe if we could jump to the 3Q acquisition guide or excuse me, just the acquisition numbers you put up and then talk about the acquisition guide for 4Q. There was a good bit of cap rate compression. Just curious what's going on in the acquisition market. And then maybe part two of that would be you have a big step up in terms of acquisition volumes. I'm curious if you can speak to the potential for maybe a transaction on the large 7-Eleven deal and And then if so, given where we've talked about cap rates being for that deal, is that accretive to your long-term weighted average cost of capital?

There's a lot of questions you've asked, John, so let me just take it one at a time. The $740 million that we did in the third quarter at a 74% cap rate, you're absolutely right. It is 50 basis points inside of what we did in the second quarter, which was a 7.9 cap. But it is also a function of the cost of capital. If you notice, our cost of capital improved during the third quarter, vis-a-vis where we were at the beginning of the year. And that improvement was about 65 basis points. So despite the 50 basis points of cash yield compression, the fact that our cost of capital had improved by 65 basis points, it was more accretive to do the transactions that we did in the third quarter. with the lower cost of capital that we were able to experience versus what we had done in the first half. So to look at anything in isolation just based on cap rate or just based on cost of capital, I think may lead you to the wrong conclusion. So I would request that you take those two pieces in conjunction to figure out what is the true spread that we are being able to cultivate through these investments. The second question that you had was around the $1.3 billion approximately that we are anticipating closing in the fourth quarter. It is true that we have a very healthy pipeline, and it is largely a function of what we were experiencing for all of the third quarter, save for what's happened over the last week, week and a half, where there's been a lot more volatility on the cost of capital side. But that has allowed us to basically build our pipeline. And we have essentially forward funded all of the $1.3 billion that we are planning on investing in the fourth quarter. So we have zero reliance at this point in the public markets to help finance what we are planning on achieving with regards to our fourth quarter numbers. The volatility in the cost of capital is something that we always take into account when we are looking at potential opportunities. And making sure that we have enough margin of safety in any particular transaction that we pursue is critical to how we think about making investments. And long term, Making sure that our hurdle rates on the long-term cost of capital is superseded by, again, a healthy margin is inherently important to what we do. I'm not going to go into specifics around what transactions make up the fourth quarter, but we've heard certain comments around there being a difference when you're buying a large portfolio versus the one-off market. I can assure you that we are in the one-off market every day. And just because you mentioned 7-11, there are 35 transactions that have taken place in 2024 year-to-date. And with the same approximate lease term, et cetera, if you look at where they traded, they traded at a 529 cap rate. Anytime we are pursuing a portfolio deal, and there were four large portfolio deals that we were able to accomplish in the third quarter, we make sure that it is at a discount to what we would be able to find in the one-off market. And that has played out if you look at what the actual rent is compared to market rent that we bought, the $740 million. The rent that is inherent in that $740 million of investments is 6% below market and 26% below replacement costs. That is why we feel very confident that on a risk-adjusted basis, the transactions that we are pursuing are ones that will create long-term value for our investors.

Thank you. And our next question today comes from Greg McGinnis at Scotiabank.

Please go ahead. Hey, good afternoon. Sumit, although you mentioned an improving acquisition environment benefiting full-year investments, based on this foray into private capital market equity raising, it seems like you're kind of inherently saying the limiting factor on acquisition volume this year has been capital raising and not lack of sourcing investments at wide enough spreads. Do you expect the cost of equity in the fund business is going to be lower? And how will investment philosophies between the fund and core business differ to avoid any potential conflicts of interest when determining where an investment should be placed?

That's a very good question, Greg. The biggest difference between the private markets and the public markets that I can point to is this focus on first-year spread versus a focus on long-term IRR. When we are looking at a particular transaction that is inside of our historical spreads, which has been 150 basis points, we hesitate to pursue that transaction because it is not in line with, you know, what we can generate in the first year. And as you know better than most, that we are valued off of that initial spread that we are able to capture, which then translates into AFFO per share growth. But that does not allow us to pursue transactions that have a similar, potentially even a higher total return profile, given the inherent growth, et cetera, that they might have, despite having a much lower initial cash cap rate. That is where we feel like being able to access private capital that has similar expectations on the long-term horizon, the return horizon, that we have, we focus on even as a standalone public entity, but not with that short-term focus as acutely as the public entity does, will allow us to expand our sandbox and make investments, you know, alongside this private capital business to take advantage of much higher growth rate opportunities, but potentially at a lower initial yield. So we think of this as truly complementary to our business. Go ahead. Were you going to ask something else?

Yeah, I just was hoping you might be able to give us maybe some examples as to types of investments or tenants that you guys have had to pass up on because of current structure versus what this – you know, this new type of equity capital will allow you to pursue.

Sure. You know, industrial is a perfect example. You know, we've looked at opportunities in the five and a half zip code. We cannot go there today as a, you know, based on where our cost of capital is. With 3% growth, 20-year leases, you do the math and you're going to have a return profile of That is very much in line with what we're looking for long term, but we can't pursue that particular transaction because of what, you know, maybe not the dilution, but the non-spread they want. That's a perfect example. There are other asset types. Data centers being a perfect example of another asset type that is going to fall squarely in this bucket. which we may not be able to pursue currently given our cost of capital. And that is a particular area of the business that we believe can help drive earnings growth for the public entity in years to come. Hopefully that gives you a bit of an insight.

Apologies, I didn't mean to interrupt. Our next question comes from Brad Hepburn at RBC Capital Markets. Please go ahead.

Yeah, thank you. So it sounds like really the target for the fund would be just a lower cap rate opportunity set. I'm curious, do you expect that there would be any overlap in the investment profiles between the two vehicles?

Of course, we are going to continue to be a very large equity holder in the fund. So, you know, our interests are going to be perfectly aligned. So there'll be a lot of, you know, opportunities that we are going to be looking at, which actually works for both entities long term, but potentially in the short term does not work for the standalone, you know, public entity. But this is also going to be a function of, you know, the capital raises. We are not going to be buying things into the fund that we would never have touched, even taking the long-term return profile into account as a public entity. So this is truly to enhance the box and to pursue transactions, assuming our capital raising is successful, and participate together through the fund structure. That is how we would like to proceed. deployed capital.

Okay. And then do you have any sort of target in mind for a size where it makes sense given just the added complication?

I hope it's going to be very simple. What causes added complication? Well, it's a different pocket of capital, but unlike pockets of capital that have finite life, this is a perpetual vehicle. And we are going to be very large co-investors in this perpetual vehicle. And for all intents and purposes, it will be fully consolidated with our financial statements. So you will have perfect visibility. The fact that we have scale and the fact that we have a platform that we are very proud of, unfortunately, does not get valued at points in time by the public markets. And this is a way for us to monetize this platform and therefore incur very little incremental cost to stand up this vehicle. That, too, is a value that our current platform is going to bring. And I might go so far as to say that, you know, given our size and scale, which we've talked about being such a massive advantage, this is one of the ways that we can show that to the markets.

Thank you. And our next question today comes from Smitty's Rose with Citigroup.

Please go ahead. Hi, thanks. I wanted to ask a little bit about the $63 million charge in the quarter related to convenience store client. And is that related to the same client where you took some smaller charges in the first half of the year? And could you maybe just talk a little bit more about kind of what the outcome will be there? I guess you can't name the client, but maybe... Just a little more color around what's going on there.

First of all, I'd say we absolutely expect a fair welcome. We've talked historically about situations where we've had credit issues in the portfolio. We've recouped north of 80% of rent that's been impacted. As it relates to the accounting aspect, that drove this $64 million charge. It's non-cash first and foremost. It really has to do with the fact that upon the allocation of the original purchase price, you've got land, you've got building, and then you've got this intangible, which is meant to account for the future cash flows inherent in the lease. And so the reserve that you see, which rolls into impairment, but it's classified because these were originally sale-leasebacks as a financing receivable. That's really just a difference in nomenclature, and that's why it's excluded from ASFO as non-cash. And we've already effectively accounted for all of the lost rent for the entirety of 2024 that's built into our guidance.

Okay. And I'll just add a little bit to that statement. Just because we're talking about credit, let me just share a bit more. I mean, these are assets that we really want control over, and we are doing everything in our power to get control over this asset. It is essentially a client who's decided not to pay rent while operating these assets. And we, you know, given the work that the asset management team has done, we already have a tremendous amount of interest in these assets, which are primarily located in Texas. And so we feel very confident about being able to replace the rent, which is not significant in this case, the actual cash rent that is, very quickly once we gain control. So that's this convenience store operator. But while we are on the topic of credit, I want to walk you through some of what has dominated the conversations over the last few quarters. Red Lobster has emerged from bankruptcy and just hired a CEO. They've hired a chief marketing officer. They've got a new CFO. Let me close the storyline on that. We had 216 assets pre-bankruptcy. Nine assets were rejected through bankruptcy. We had a 91% recapture rate. on that particular name. Rite Aid, we have 29 locations today. We had an 88% recapture rate on Rite Aid, which has now emerged from bankruptcy and is an ongoing concern. Regal, where we have 35 assets today, had an 85% recapture rate, and it has emerged from bankruptcy. So those are the storylines that had dominated, you know, multiple quarters of conversations. And this is the end result of all of those conversations. Let's talk about Walgreens. Everybody's concerned about, you know, what used to be a 2,000 store closings, which has now been reduced to 1,500. Year to date, we'd had 13 Walgreens come up for renewal. They had lease maturity. All 13 were renewed by Walgreens. In our history of 55 renewals with Walgreens, we've had a recapture rate of over 100%. Let's throw CVS in that mix. We've had 40 leases renew with CVS in our history at over 102% renewal. Let's talk about a family dollar, Dollar Tree. We've had 135 lease renewals. with Family Dollar Dollar Tree in our history at over 108% renewal rate. Dollar General is a similar story. So I just ask that what we see in the headlines don't necessarily translate to what is happening on the ground for our portfolio. And that's the emphasis I want to make, is that we are very selective, and the data proves that out to be the case. Go ahead, Smeet. Sorry, I cut you off.

No, no, I mean, I appreciate the detail. I was understood. But of course, you know, as we see these headlines, we have to, we have to ask about them, right? I mean, you know, that's the nature of the business. I wanted to ask you on the, just going back to the fund for a moment, you, I think it was asked previously, but I don't think I heard the answer. Just do you have a sense of kind of what the scope of the fund would be? Are we talking maybe a billion dollars to start or would you see it in, several billions, or kind of how do you think about the size of the fund, I guess, initially and maybe how it might grow over time?

Yeah, it's too early to tell. We obviously believe in our pieces. We believe in what we are doing. We believe the benefits of what we are doing is going to accrue to our public shareholders. But it is too early for me to opine on how big this could potentially become.

Thank you. And our next question today comes from Jay Kornreich with SMBC. Please go ahead.

Hi, good afternoon. I was wondering if you can comment on kind of just the opportunities that you're currently seeing in Europe. And as you see things today, are you looking into exploring into new territories and do you expect that acquisition opportunity in Europe to continue to outpace the U.S.?

That's a great question, Jay, given what we've done in the first three three quarters, it is a legitimate question. Yes, 56% of what we've done here today has been in Europe, but we view that as an advantage. That's precisely the reason why we created all of these growth verticals, to be able to take advantage of wherever the best opportunities reside. And Europe is where we found that to be the case for the first three quarters. I believe the momentum in Europe will continue. We are seeing very good opportunities in Europe. And yes, our ability to go beyond our current geography, by geography I mean countries in Europe, is also something that we are constantly looking. And so for the right opportunity, there are several countries that we don't happen to be in that we would consider going into. with the right client and with the right opportunity. Okay, thank you.

Thank you.

Rocco, one second. Jay had asked about the future as well. And so, you know, the $1.3 billion that's expected in the fourth quarter, I want to close the loop on that. The momentum that I had referenced was the momentum that we are seeing here in the U.S. In Europe, the momentum has continued. It's been there at the beginning of the year. That momentum has continued. But it's in the fourth quarter that you will see it reverting back to more historical norms in terms of U.S. versus internationals.

Thank you. And our next question today, yes, sir, comes from Handel St. Just in Mizzou. Please go ahead.

Hey, guys. I guess good morning out there to you. Suman, I wanted to go back to the fund one more time. There appears to be a long list of benefits that you mentioned already, but I'm also thinking that there could be a long-term benefit of allowing you at some point to potentially generate mid-single-digit AFO growth, your long-term kind of core growth target, without the need to for sizable annual equity raises when you think about your existing rent bumps and the reinvestment of your free cash flow. So I guess first, is that fair? And then maybe some color on if you'd look to fund it with existing assets within your portfolio and what that mix could look like. Thanks.

That's a very good question, Handel. Thank you. And you're right. I mean, the idea here is we get into this business to expand the investable universe for ourselves and for the fund, while making sure that we adhere to the return expectations of all parties concerned. Look, it's a mathematical fact that it's not an issue today, but 10 years from now, at the rate we are growing, if we continue to rely on just the public markets to finance our growth, they're going to run up into capacity issues. I don't believe that the public markets are, especially the fund business and the public markets, are growing at the same level that we have expectations of growing as a public entity. And so it is not a dearth of opportunities that is driving growth. this desire to get into the fund business, it is making sure that this complementary source of equity capital will help us monetize our platform and create a business that will then allow us to continue the momentum that we have shown over the last 55 years, 30 of which has been as a public entity. That is the goal of what we are trying to do. And outside of the initial you know, call it seeding of this fund, which, by the way, that portfolio will look and feel very similar to what realty income looks like, and at the appropriate time all of that will get disclosed, is a way to attract capital and start our business. But subsequently, you know, it will be new transactions, that they participate in either alongside us or it will be on balance sheet for the public entity. That's how the business is going to function. I hope you have a clear handle.

No, that's incremental. I appreciate that. And one more, and I'm not sure if you answered it, but I didn't quite catch if the pipeline for the fourth quarter, if you expected cap rates to be comparable or lower, and then just thinking about the uptick in volume into the fourth quarter, if that's an appropriate run rate to think about into next year. Thank you.

Yeah, Handel, I'm not going to opine on cap rates, et cetera, because things can move around quite a bit. But what I will tell you is that the spread that we are going to make will continue to be healthy and will continue to be north of our historical spreads. That you can take a fair amount of confidence. And the other piece I'll leave you with, Handel, is we have already pre-funded our need for the fourth quarter. So there is no reliance on the public markets to help fund this $1.3 billion that we are planning on doing in the fourth quarter. Hopefully that helps.

Thank you. And our next question today comes from Spencer Allaway with Green Street Advisors. Please go ahead.

Yeah, thank you. One more on the private fund. Can you maybe just talk about how time will be spent just in terms of underwriting deals and opportunities for the team in general, but also for you, Suman? And then I know you commented on economies of scale around your data and data analytics, but just curious if you foresee any changes to headcount or to the investment process just in the early stages of that launch.

That's a great question, Spencer, because it really goes to the heart of when I say we're going to use our scale as you know, as a company that we are today, to mitigate what would be an insurmountable cost for a startup to start this business. You know, we have 465 people in the business. We already have a fully staffed investment arm both here in the U.S. as well as in the U.K. and in Amsterdam taking care of our international business. So we don't see any need – for any incremental personnel on the investment side. That's scale benefit number one. Scale benefit number two, we are going to be agnostic as to whether these assets are held in a fund, which by the way, the public entity will have a fairly large interest in, or whether it is on balance sheet. And that's our asset management team that has done a superb job on the public side, both here in the US as well as in the international markets in London, they will continue to manage these assets. That's scale benefit number two. Any dispositions, any elements of that, we already have the team here. We have a very large legal team that we are going to leverage that obviously is a massive source of pride for us given that we do a majority of the work in-house We will continue to lean on them to help, you know, with transaction negotiations, lease negotiations, et cetera. That's scale benefit number three. You know, we already have the setup in place, and so we are not going to be needing new people to help do the block and tackle work that is required of an investment arm. Where we will have incremental cost will be around a fund manager, and the reporting as well as an IR function that will be dealing with a very specific type of investor base on the private side. But outside of that, from accounting, finance, which by the way is again something we are very proud of, will all be leveraged, you know, with the existing platform that we have. That's my comment around the incremental cost in standing this business up will be, you know, fairly muted.

Okay, thank you. That was very helpful. And just last one, can you talk about how the competitive landscape is changing or if there's been any changes in the U.S. and Europe right now as it relates to the transaction market?

Yeah, Spencer, it's very fluid in terms of who we are starting to compete against. There is no doubt that private arms are becoming much bigger players in transactions that we are pursuing. And, you know, and, of course, we've had a few more companies in the net lease space that have become public. We don't run into most of them, you know, given the types of transactions that we pursue. But it is a crowded field in terms of competition here in the U.S., In the international market, it continues to be one of the biggest advantages that we have, where we are running into more competition today than we did, let's call it, a year or two years ago. But it's still not quite as intense as what we experience here in the U.S. And most of that competition comes from private capital in the international market. So that's the flavor of who we compete against. in the U.S. and in the international markets.

Thank you. And our next question today comes from Upal Reyna with KeyBank Capital Markets. Please go ahead.

Great. Thanks for taking my question. Subha, you talked about the momentum in the transaction market, but I wanted to kind of get a sense on on have buyers and sellers really reacted to the 50 basis points rate cut and with another 25 basis points cut likely this week and then with the 10-year really you know driving higher about 65 basis points since the last fed rate cut so i want to get your good sense on that yeah i think google so much of the volatility across the curve at this point is around what will happen today

um and you know it's the largest exogenous factor that's going to determine where the curve settles down we are not as exposed to the short end of the curve we are you know but but it's not to the same extent as we are to the long end of the curve and so what's happening on the long end of the curve definitely has an impact on our cost of capital because that becomes our permanent source of financing and you know our ability to pursue transactions And that is a function of inflation expectations that people have about the future. And if policies are going to get put into place where the inflation expectation is going to suddenly be much higher than what it had been traditionally, that is going to have an impact on where the tenure is going to settle. And that will certainly have an impact, either on the positive side or on the negative side, for the permanent cost of capital for a net lease business. And those are largely policy driven. We've had two parties coming up with proposals that have diverse set of impacts on this particular inflation expectation. So too early to tell where all of this is going to settle. It is creating a fair amount of volatility. And we are hopeful that regardless of who wins, once we have more clarity in terms of what the curve is going to look like, we'll be able to execute on business as usual.

Great. That was helpful. And then last one from me, going back to the private capital fund, I know you've already listed a bunch of benefits there, but I want to get your sense on why now and why this makes sense in today's economic environment. And I know you mentioned capacity could be an issue in the future, but is there anything else that you may have been dealing with that was creating some friction on your end?

Really, Opal, there is nothing that we are seeing either on the credit side. I think I went through a pretty detailed list to share with you that On the credit side, we feel very good. Our credit watch list actually came down by 10 basis points to 4.2% from the previous quarter. So we feel very good on the credit side. We feel very good on the health of the market to precipitate transactions, setting aside what's happened over the last couple of weeks. But that too shall pass is our expectation. Really, the timing is around to do this right, which obviously is our collective desire. We want to do this very slowly, and we want to do it very thoughtfully, and it's going to take a long time, a long time for this to become a mature business. I mean, look at one of our peers who has probably one of the most successful open-ended fund businesses, and that's Prologis. And they've been in that business for 20-plus years. And today, It has become, you know, we can step back and say it is a super successful business that some very smart people went into 20 years ago. And so in anticipation of what could happen, you know, 10 years from now, et cetera, when we start to run up against this, you know, our desire to put out capital and perhaps, you know, the limits of just accessing the capital sources that we have today, that could become more acute. And so we have to start today to build this history and to build this fund business to a point where it really starts to bear fruit for our public shareholders, et cetera. And that's it. That's why we are doing it today. There is no, you know, it doesn't matter at which point in the cycle we would have done this. That question would and should be asked. But it's really about starting now when we don't have a need for additional capital. and building this business to get ahead of what could be, you know, a limiting factor multiple years down the road.

Thank you. And our next question today comes from Linda Tsai with Jefferies. Please go ahead.

Hi. Just a few quick ones. Can you give us an update on where 2024 bad debt year to date has trended and what's your outlook for 25?

Yeah, so Linda, if you look at the Earnings released first nine months of this year, we've incurred about $16 million in bad debt expense. That's around 40 basis points of our rental revenue. When you take out this one C-store operator that we referenced earlier, you're really looking at sub-20 basis points, like 18 basis points. We've talked historically about how when you exclude the pandemic, you know, we've been right there at around 25 basis points of credit loss in a given year as a percentage of revenue. So to be at 18 outside of this one-time unusual event, you know, we think is pretty indicative of a very constructive and healthy portfolio. And I think, you know, we, as Suman alluded to earlier, you know, the credit watch list at 4.2%, there's really not a lot out there that we're really monitoring that meaningful. There's no one plus percent exposure tenants on there. We feel as though those that are on the watch list, we've been monitoring for quite some time. And in some cases, we have very good visibility into the cashflow coverage on these assets. And so we'll get into all of the assumptions that we're baking in for 2025 come February when we release our guidance.

And then in terms of the C-Store write-down in the quarter, what's the potential AFFO impact on earnings? And then what do you think is the recapture rate?

So in terms of this one C-Store operator, it's really, you know, you can call it a million a month or so. And all of that is built in. All of that is built into our guidance. And, you know, we'll see where we trend out to in terms of recovery. But as we referenced earlier, we do feel like there's could be quite a bit of interest in these assets. So I think the default response that we would offer up is you look at our historical precedents and being able to get 84, 85% recapture of any rent that's been impacted by some bankruptcy or credit event.

Thank you. And our next question today comes from Ronald Camden with Morgan Stanley. Just go ahead.

Hey, just two quick ones back to the fund. I think you talked about some of the investments that would be interesting in the fund where the public equity couldn't do it. I guess my other question is just, is there any other differences in terms of dividend policy, in terms of geography, like can the fund go anywhere? And in your mind, is that investor that's going into the fund, is that a completely different investor base that would contemplate the stock, or is there some overlap? Thanks.

Ron, we haven't really done any work on the investor profile, but the comments I made about how much bigger this investable universe is of potential investors who look to invest in real estate through a fund structure is what's so compelling. Is it possible that you have some of these funds that have a ambit to invest in public securities and they have a mandate to invest in private direct investments? I'm sure that that may be the case. But even those investors will tell you that what they have to invest through a fund structure directly into real estate is multiples of what they have on the security side. So I can't give you a more precise answer than that, but the vast majority, I believe, are going to be investors who, you know, don't have the ability to invest in public securities but would like to utilize our platform, work with us, and invest in the product that we invest in. And outside of that, you know, the strategy is one that I've already touched on. There's not going to be anything new that the fund business is going to be doing that we won't do on balance sheet. Keep in mind that, you know, the goal is we will be a massive co-investor in this fund. And so our interests are going to be perfectly aligned in terms of, you know, what it is that we pursue.

Great. And then my second quick one is just – Just an update on sort of the data center sort of initiatives. Obviously, there's been a lot of data points about demand ramping. Just how are you guys sort of seeing the pipeline and that vertical evolving?

Yeah, so I won't talk about pipelines, Ronald, but what you've referenced in terms of the demand, we're seeing that in spades. And, you know, we've been very lucky to be speaking with multiple operators in this space. We see it in terms of what they're showing us regarding the pipeline that they've created. We are trying to craft a value proposition that is compelling to these operators. And we are very optimistic about where this particular business could go for realty income. going forward. We feel like we can be a solution that helps meet some of the demand and the capital needs to execute on what is a once-in-a-cycle type situation. And at the end of the day, we are capital allocators. And if we can allocate capital exposed to S&P 10, S&P 20 clients for 20 years, That's our core business, and so we are excited, but it's too early to tell in terms of how this is all going to play out.

Thank you, and our next question today comes from RJ Milligan at Raymond James. Please go ahead.

Hey, thanks, and good afternoon. I wanted to ask a couple more questions on the funds, giving those examples of some of the transactions that might be more appropriate there has been helpful, and I just I just want to be clear, do you expect the fund to invest in properties that might not necessarily have triple net leases and therefore have better internal growth or more structured investments, development loans? I'm just trying to get an idea of what the mix is or if it's going to be pure triple net.

RJ, you know, what I'll share with you is you should think of these investments in terms of flow through, you know, rental income flowing through to NOI to be very similar to what we've, you know, done on balance sheet date. The idea is not to go and start executing on businesses that, you know, have a 40% NOI margin. That's, that's not what we do. And so, you know, um, when we talk about data centers, we are not going to be going out there and buying co-location sites where the flow-through is very different versus hyperscale single-tenant 20-year leases that may not be precisely triple net, but the flow-through is still incredibly high, i.e. mimicking what a triple net asset should be generating. That's really the what we are going to be doing.

Okay. And then two quick follow-ups and I may have missed the answers, but number one, do you expect the cost of equity to be higher or lower than realties?

The cost of equity as defined by long-term return hurdles should be very similar, you know, but their focus is, is on the long-term hurdle rate not on day one accretion you know and that's the big difference rj that's why i gave the examples that i did that you know the return profile long term is very similar for both of these businesses but we as a public entity 100 public entity today cannot meet our dual mandate of generating that year one spread and the long-term hurdle rate. Both those have to be met in order for us to pursue transactions in the public markets today. That's how we are valued, and we are very grateful for that. We understand that that's the game we have to play. But there are assets that we are passing up on, very high-quality assets that can meet the long-term hurdle, but will potentially have a much lower starting point. And that, I think, is what we'll be able to do through this fund structure and enhance our co-investment, you know, through the recurring asset management fee stream, which is essentially the monetization of the platform that we have to the benefit of our public shareholders. That, that's how this, this, you know, will work.

Okay. And one last follow-up is, um, will realty income be contributing properties to the fund?

Um, There will be a seed portfolio that will allow us to have conversations with potential investors. But thereafter, it will be new investments that we pursue. That's how we're thinking about it today. So outside of that initial seed portfolio, everything else will be new transactions that we'll be pursuing.

Thank you. And our next question comes from Greg McGinnis at Scotiabank. Please go ahead.

Hey, Sumit. I just wanted to follow up on that last question. So, you know, you mentioned Prologis, right? And I think that's where the contribution question comes from. But, you know, could you instead maybe envision, you know, increasing investment into developments, which maybe otherwise you wouldn't have underwritten? that would then be contributed to the platform? Or would you instead pursue those developments within the platform itself?

You know, Greg, that's a very good question because when we pursue development, we do have certain accounting elements that we have to adhere to. And there are times where we are unable to recognize the full cash impact, the positive cash yield that we are able to generate on dollars that we are investing in a development scenario, just given the lease accounting that we have, that's certainly not going to be a prohibitive factor doing it through the fund structure. And so could we do more of those? Yes. In the fund, the answer is yes. But again, it needs to meet and exceed the overall return hurdles that we would need to address. So there are a lot of things that this alternative source of financing could allow us to do, which we have done as a public entity, but only in a limited way because of some of the inherent limitations that we have either in terms of how we can report stuff, et cetera. So I do think that this will give us the flexibility and thus the comment I made about expanding the sandbox of the types of transactions that we would be able to pursue by having this alternative source of capital available to us.

Do you already have kind of first investors in mind or conversations that you've had along this front?

We have none of that in mind. We have, you know, and I think I've talked about this, what the profile of this investor could look like. We certainly have that. And we are working with our advisors who have shared with us, you know, what the details are around that. But we haven't, you know, we haven't had any conversations today.

Okay, and just a final follow-up for Jonathan. Is there anything specific to point to in the slight increase in the midpoint to the expense leakage guidance?

Yeah, it's a combination of a few things, Greg. You know, first of all, there's been some deferred expenses that we've brought forward, some that were carried forward from last year. We're just trying to get ahead of spend and trying to catch up in some cases. So there is a little bit of heavier load this quarter. I would also say, or this year, I would also say that there are some carry costs that we are incurring with a few vacant assets that do comprise a bit of an increase on a year-over-year basis from a margin perspective. And then also I think when you're just comparing it to the 1.1% leakage that we experienced last year, keep in mind we did bring in, you know, a $9 billion portfolio in January with the Spirit portfolio, and that did have slightly more leakage as well, you know, just on a run rate basis. So I would really attribute it to those factors as what's driving the slight increase going from 1.1 and now to a midpoint of 1.35%.

Thank you. And our next question today comes from Wes Gallaudet with Baird.

Please go ahead. Hey everyone. I just want to have a question on the development pipeline. When do you expect the non-retail to lease up? Are you holding back leasing on that right now?

Yeah, that's a great question, Wes. Look, it's a very small portion of the overall development. I think it's like 15% plus minus in that zip code. even though the quantum that we have identified for this particular type of development, we really don't spend until we get clarity on the leases coming through. And so we feel very confident. We are partnering with one of the best developers in Panettone, and we feel very confident that some of these are going to get leased up in the near term. And keep in mind, we won't make the big capital investment without, you know, having line of sight on, you know, potential clients being able to step in and take over those leases.

Maybe just a quick follow-up on that. Since it's more spec in nature, are you going to get a little bit more incremental yield?

Yes, absolutely. And, in fact, in situations where, you know – We've had two buildings, one was leased and the other one wasn't. We have expectations on what we think the lease rates are going to be. And so far, more often than not, those lease rates, our expected lease rates have been superseded by what actually ends up happening. So this continues to build a fair amount of confidence in not only our partner, but also our team's ability to underwrite these types of transactions.

Thank you. And this concludes our question and answer session. I'd like to turn the conference back over to Sumit Roy for any closing remarks.

Thank you all for joining us today. We look forward to speaking soon and seeing you at a conference in the upcoming weeks. Thank you, guys.

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.