Realty Income Corp (O) 2019 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Realty Income Fourth Quarter and Year-End 2019 Operating Results Conference call.

(Operator Instructions)

I would now like to hand the conference over to your speaker today, Andrew Crum, Associate Director, Realty Income.

Please go ahead.

Thank you all for joining us today for Realty Income's Fourth Quarter and Year-End 2019 Operating Results Conference Call.

Discussing our results will be Sumit Roy, President and Chief Executive Officer.

During this conference, 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.

We will disclose in greater detail the factors that may cause such differences in the company's Form 10-K.

(Operator Instructions)

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

Thanks, Andrew.

Welcome, everyone.

We completed another year of strong operating performance, delivering favorable risk-adjusted returns for our shareholders.

We are pleased to have provided our shareholders with more than 21.2% total shareholder return in 2019.

During the year, we invested over $3.7 billion in real estate properties and increased AFFO per share by 4.1% to $3.32 per share.

2019 was a record year for property-level acquisitions and included approximately $798 million in international investments, including our first-ever international sale-leaseback of 12 properties located in the United Kingdom leased to Sainsbury's, a leading grocer.

In 2019, we celebrated the 50th anniversary of our company's founding and the 25th year since our public listing.

And we were proud to be added to the S&P 500 Dividend Aristocrats Index earlier this month for being an S&P 500 constituent that has raised its dividend every year for the last 25 consecutive years.

We entered 2020 very well positioned across all areas of the business and are introducing 2020 AFFO per share guidance of $3.50 to $3.56, which represents annual growth rate of approximately 5.4% to 7.2%.

Earlier this month, we announced that Paul Meurer, Chief Financial Officer and Treasurer, is leaving the company.

To ensure a smooth transition, Paul will serve as senior adviser to the company through the end of the first quarter, and the company has begun a search for a new Chief Financial Officer.

I want to thank Paul for his valued partnership and tremendous contributions to the company over many years.

Our portfolio continues to be diversified by tenant, industry, geography, and to a certain extent, property type, which contributes to the stability of our cash flow.

At quarter end, our properties were leased to 301 commercial tenants in 50 different industries located in 49 states, Puerto Rico and the U.K. 83% of our rental revenue is from our traditional retail properties.

The largest component outside of retail is industrial properties at nearly 12% of rental revenue.

Walgreens remains our largest tenant at 6.1% of rental revenue.

Convenience stores remains our largest industry at 11.6% of rental revenue.

Within our overall retail portfolio, approximately 96% of our rent comes from tenants with a service, nondiscretionary and/or low price point component to their business.

We believe these characteristics allow our tenants to compete more effectively with e-commerce and operate in a variety of economic environments.

These factors have been particularly relevant in today's retail climate where the vast majority of the recent U.S. retailer bankruptcies have been in industries that do not possess these characteristics.

We continue to feel good about the credit quality in the portfolio, with approximately half of our annualized rental revenue generated from investment-grade-rated tenants.

The weighted average rent coverage ratio for our retail properties is 2.8x on a four-wall basis, while the median is 2.6x.

Our watch list at 1.9% of rent is relatively consistent with our levels of the last few years.

Occupancy based on the number of properties was 98.6%, an increase of 30 basis points versus the prior quarter.

We expect occupancy to be approximately 98% in 2020.

During the quarter, we re-leased 28 properties, recapturing 106% of the expiring rent.

During 2019, we re-leased 214 properties, recapturing 103% of the expiring rent.

Since our listing in 1994, we have re-leased or sold over 3,100 properties with leases expiring, recapturing over 100% of rent on those properties that were re-leased.

Our same-store rental revenue increased 2% during the quarter and 1.6% during 2019, which is above our full year projection of approximately 1%, primarily due to the recognition of percentage rent.

We expect same-store rent growth to normalize in 2020, and our projected run rent -- run rate for 2020 is approximately 1%.

Approximately 86% of our leases have contractual rent increases.

Moving on, I will provide additional detail on our financial results for the quarter and year, starting with the income statement.

Our G&A expense as a percentage of revenue was 4.3% for the quarter and 4.7% for the year, which was consistent with our full year projection of below 5%.

We continue to have the lowest G&A ratio in the net lease REIT sector and expect our G&A margin to be approximately 5% in 2020.

Our nonreimbursable property expenses as a percentage of revenue was 1.4% for both the quarter and for the year, which was lower than our full year expectation in the 1.5% to 1.75% range.

Briefly turning to the balance sheet.

We have continued to maintain our conservative capital structure and remain one of only a handful of REITs with at least 2 A ratings.

During the fourth quarter, we raised $582 million of common equity primarily through our ATM program at approximately $75.52 per share.

For the full year, we raised $2.2 billion of equity at approximately $72.40 per share, finishing the year with a net debt-to-EBITDA ratio of 5.5x.

And our fixed charge coverage ratio remains healthy at 5x, which is the highest coverage ratio we have reported for any quarter in our company's history.

In January, we completed the early repayment of our $250 million, 5.75% 2021 bond through a full par call.

Looking forward, our overall debt maturity schedule remains in excellent shape as the weighted average maturity of our bonds is 8.3 years, and we have only $334 million of debt coming due in 2020.

And our maturity schedule is well-laddered thereafter.

In summary, our balance sheet is in great shape, and we continue to have low leverage, strong coverage metrics, ample liquidity and excellent access to well-priced capital.

In the fourth quarter of 2019, we invested approximately $1.7 billion in 556 properties located in 42 states and the United Kingdom at a weighted average initial cash cap rate of 6.8% and with a weighted average lease term of 11.2 years.

Approximately $1.2 billion of this quarter's acquisitions were related to the CIM portfolio acquisition we announced in September.

On a total revenue basis, approximately 47% of total acquisitions during the quarter were from investment-grade-rated tenants.

100% of the revenues were generated from retail tenants.

These assets are leased to 78 different tenants in 26 industries.

Some of the more significant industries represented are convenience stores, dollar stores and drugstores.

We closed 12 discrete transactions in the fourth quarter, and approximately 10% of fourth quarter investment volume was sale-leaseback transactions.

Of the $1.7 billion invested during the quarter, $1.5 billion was invested domestically in 551 properties at a weighted average initial cash cap rate of 7% and with a weighted average lease term of 10.6 years.

During the quarter, $221 million was invested internationally in 5 properties located in the U.K. at a weighted average initial cash cap rate of 5.2% and with a weighted average lease term of 17.1 years.

During 2019, we invested over $3.7 billion in 789 properties located in 45 states and the United Kingdom at a weighted average initial cash cap rate of 6.4% and with a weighted average lease term of 13.5 years.

On a revenue basis, 36% of total acquisitions are from investment-grade-rated tenants.

95% of their revenues are generated from retail and 5% are from industrial.

These assets are leased to 112 different tenants in 31 industries.

Of the 72 independent transactions closed in 2019, 11 transactions were above $50 million.

Approximately 38% of 2019 investment volume was sale-leaseback transactions.

Of the $3.7 billion invested in 2019, nearly $2.9 billion was invested domestically in 771 properties at a weighted average initial cash cap rate of 6.8% and with a weighted average lease term of 13 years.

During 2019, approximately $798 million were invested internationally in 18 properties located in the U.K. at a weighted average initial cash cap rate of 5.2% and with a weighted average lease term of 15.6 years.

Transaction flow remains healthy as we sourced approximately $11.7 billion in the fourth quarter.

Of the $11.7 billion sourced during the quarter, $9.8 billion were domestic opportunities and $1.9 billion were international opportunities.

Investment-grade opportunities represented 17% of the volume sourced for the fourth quarter.

Of the opportunities sourced during the fourth quarter, 58% were portfolios and 42% or approximately $5 billion were one-off assets.

In 2019, we sourced approximately $57 billion in potential transaction opportunities, which marks the highest annual volume sourced in our company's history.

Of this $57 billion sourced in 2019, 42% were portfolios and 58% or approximately $33 billion were one-off assets.

Of these opportunities, $45 billion were domestic opportunities and $12 billion were international opportunities.

Of the $1.7 billion in total acquisitions closed in the fourth quarter, 15% were one-off transactions.

As to pricing, U.S. investment-grade properties are trading from around 5% to high 6% cap rate range, and noninvestment-grade properties are trading from high 5% to low 8% cap rate range.

Regarding cap rates in the United Kingdom for the type of assets we are targeting, investment-grade or implied investment-grade properties are trading from the low 4% to high 5% cap rate range, and noninvestment-grade properties are trading from the 5% to the low 7% cap rate range.

Our investment spreads relative to our weighted average cost of capital were healthy during the quarter, averaging approximately 325 basis points for domestic investments and 228 basis points for international investments, both of which were well above our historical average spreads.

Our investment spreads for 2019 averaged 271 basis points for all of our investment activity, representing the widest annual spreads in our company's history.

We define investment spreads as initial cash yield less our nominal first year weighted average cost of capital.

Our investment pipeline, both domestic and international, remains robust.

And we believe we are the only publicly traded net lease company that has the size, scale and cost of capital to pursue large corporate sale-leaseback transactions on a negotiated basis.

Based on the continued strength in our investment pipeline as well as our excellent access to well-priced capital, we are introducing 2020 acquisition guidance of $2.25 billion to $2.75 billion.

Our disposition program remains active.

During the quarter, we sold 29 properties for net proceeds of $36.3 million at a net cash cap rate of 6.8%, and we realized an unlevered IRR of 10.4%.

This brings us to 92 properties sold in 2019 for $108 million at a net cash cap rate of 8.1%, and we realized an unlevered IRR of 8.3%.

We continue to improve the quality of our portfolio through the sale of nonstrategic assets, recycling the sale proceeds into property that better fit our investment parameters.

We are expecting between $200 million and $225 million of dispositions in 2020, a large portion of which already closed earlier this month.

In January, we increased the dividend for the 105th time in our company's history.

Our current annualized dividend represents an approximately 3% increase over the year-ago period and equates to a payout ratio of 79% based on the midpoint of 2020 AFFO guidance.

We have increased our dividend every year since the company's listing in 1994, growing the dividend at a compound average annual rate of approximately 4.6%.

And we are proud to be 1 of only 3 REITs in the S&P 500 Dividend Aristocrats Index.

To wrap it up, it was a successful and active year for us in 2019, and we look to continue the momentum in 2020.

Our portfolio is performing well, our global investment pipeline is robust, and our cost of capital and ample liquidity positions us to capitalize on our growth initiatives.

At this time, I'd like to open it up for questions.

Operator?

(Operator Instructions) Our first question comes from the line of Nick Yulico with Scotiabank.

This is Greg McGinniss on with Nick.

Digging into the acquisitions guidance a bit.

We're curious if you could give us the estimated split between the U.S. and U.K., whether the EU's an option for 2020 and what cap rate or investment spread is assumed in the underwriting?

The makeup is going to be approximately 20% international and 80% domestic.

And the spreads are going to be -- our hope is well north of our average spreads of 150, 160 basis points.

Okay.

So coming in a bit from what you guys accomplished.

And I'm assuming that's just more conservatism than anything else?

That's what we feel very comfortable sharing with the market.

Obviously, what happened last year, it is something that we expect to continue.

But we feel very confident in being able to say that our range in the acquisition is going to be in that $2.25 billion to $2.75 billion.

And we hope to do far better than our average spreads, which as I said, was right around 150 to 160.

So yes, a certain level of conservatism.

Okay.

And then -- so we know the acquisition guidance does not include potential portfolio acquisitions.

But could you give us maybe some sense for what you're seeing out in the market today on that front?

And are there portfolios currently being marketed to you?

Are you looking at any right now?

What are the size?

I'm just trying to get a sense of what a reasonable upside is to acquisition guidance.

Yes.

So let's be a little bit clear on what we are defining as portfolios.

The large portfolio transaction that we did last year was that $1.1 billion CIM transaction -- $1.2 billion CIM transaction.

That's the kind of transaction that hasn't been sort of built into our $2.25 billion to $2.75 billion number.

Clearly, we are in the market and are constantly doing portfolio sizes in the range of $100 million to $200 million, and those are very much part and parcel of what's included in our guidance.

Look, we've shared with you what the sourcing numbers were for 2019.

We haven't seen any letup in terms of what we are seeing so far and so early in the year.

We are very optimistic about the pipeline, and we are very optimistic of meeting the guidelines that we have shared with the market.

And at this point, there is nothing that we are seeing in the horizon that would lead us to believe that this is going to be a much slower year than what we saw last year.

Our next question comes from the line of Christy McElroy with Citi.

Just with a pickup in some of the open-air retailers filing for bankruptcy and announcing closures in recent months and also reports of others hiring restructuring advisers, can you talk about any specific tenants that you have exposure to that fall into this category or any pockets of your exposure where you're concerned about fallout as you look into the next year?

There are some tenants that we are obviously looking at very closely.

The good news here is we are so well diversified, Christy, that these are tenants that have very minimal, well below 1% exposure to.

For instance, Pier 1 is one of our tenants that we are looking at.

It's been on our credit watch list for a while.

We have 12 assets with them.

It's right around 10 basis points of rent.

We did a sale/leaseback with them in 1998.

And it's actually been a great transaction for us.

So we are almost indifferent as to what happens with them.

On 9 of the 12 properties, we are already getting inbound calls from large national tenants that gives us very high level of confidence that we'll be able to reposition this asset.

A couple of other names that we are keeping a close eye on -- Krystal is another one that we acquired through a large portfolio, again, basis points of rent.

And based on the four-wall coverage, we feel our portfolio is very well positioned.

And once again -- but that's a corporate-level credit that is in the news and one that we are looking at very closely.

But in aggregate, we have obviously taken all of this into account in forecasting out our AFFO per share guidance.

And so you can tell from the guidance that we have laid out, Christy, that, fingers crossed, this year will again be a very, very good year for us.

And you talked about in your opening remarks the spreads in market cap rates between investment grade and non-investment grade.

Do you think those spreads are wide enough, just given sort of that kind of fallout environment you're seeing?

And I think I heard you say that about -- something about 70% of the deals that you're sourcing are investment grade versus, I think, it's 50% in place.

So will there be a continued effort to sort of raise investment-grade exposure?

Actually, what we are seeing is something very interesting, Christy.

I would argue that some of the higher-yielding assets have compressed with regards to cap rates and are moving closer to where investment-grade cap rates are in the market.

So it hasn't been a movement in the investment-grade market that is as pronounced as it is in the higher-yielding market.

So one must take into consideration, on a risk-adjusted basis, where are you better off investing.

And I think we've shared this with you in the past, Christy.

Credit is very much part of the analysis that we undertake, but we are not pursuing a particular credit profile.

We are looking at it in totality and trying to come up with, for the risk that one is assuming, are the returns appropriate.

That's how we look at all of our investments.

And -- but the point I want to make is higher-yielding assets that used to have a high 7, even an 8 cap rate, are now trading at a 6 cap rate.

And investment-grade assets that were potentially in the high 5s are in the low 5s.

So it's a far more pronounced compression that we are seeing in the higher-yielding side of the equation, and it does give us pause when we look at it from a risk-adjusted basis as to whether we should continue to pursue all of those transactions.

Our next question comes from the line of Shivani Sood with Deutsche Bank.

Just following up on the earlier question about portfolios.

Curious if you're seeing increased competition for larger portfolio acquisitions or sale/leasebacks from private players in recent months.

And how has that changed how you're sourcing and approaching the process to remain ahead of them?

Yes, Shivani, for us, it's business as usual.

We are not changing any of our methods of sourcing or pursuing potential transactions that have a risk profile that is not justified by the cap rates that's being ascribed or that's being asked.

I mean we have -- we did -- 89% of our transactions in 2019 were relationship-driven transactions.

We are continuing to pursue those.

We continue to reach out to clients of ours that have credit that we feel very comfortable with.

These are assets that don't even get marketed, and we continue to build on the sale/leaseback side of the equation.

And absent CIM, 61% of what we did last year was sale/leaseback.

So I wouldn't say that, in any way, we have altered the way that we are pursuing acquisitions.

What we have done on the international side of the equation is, obviously, we have continued to establish new relationships with, again, having done the homework around clients that we would like to pursue over the long term.

And that has been a major push for Neil and for myself to continue to grow our international platform.

And thankfully, we've made a fair amount of progress on that front.

Just switching topics, the recapture rate for occupied boxes is really good in the quarter.

Can you share some more color on what drove that?

Yes, sure.

So there were basically 2 things that drove that.

And then as you can see, our 2020 guidance is right around 1%, which has traditionally been what we have said.

Not every lease that we have has an annual rent growth.

Some have rent growth every 3 years.

Some have rent growth every 5 years.

And it just so happened that a disproportionate number of leases had growth coming in, in 2019.

For instance, if you looked at the dollar stores, 46% of all the assets that we own within that bucket had an increase in 2019, and most of those were either a 3- or a 5-year rental increase.

And that accounted for about 34% of the disproportionate increase in the rent, the 1.6% that we were able to achieve.

On a second note, a smaller contribution to the increase was the timing of the percentage rent accruals, and that, too, helped.

But if you were to take those 2 out of the equation, we would be right around what we have guided the market to for 2020.

Our next question comes from the line of Rob Stevenson with Janney.

How are you feeling these days about the office segment?

I mean you've added one asset in the last year.

Is that a source of dispositions going forward?

Is that a source of acquisitions going forward?

I mean what's the -- how do you think about that over the next 3 years?

Rob, so as far as I know, our exposure to office has continued to dwindle over the last few years.

It used to be north of 6% at one stage.

Today, it's in the 3% ZIP code.

And it's a product type that we have accumulated largely through large portfolio transactions.

We haven't proactively gone out and bought some single-tenant net leased office assets.

Having said that, the commentary I'm sharing with you is very much a U.S.-based commentary, but I suspect that it is going to be very similar even in the international market.

So our view regarding office has not changed.

It's an asset type that we are very cautious about, and we tend to be very, very selective when we even take a particular opportunity and do a deep dive into underwriting the opportunities.

Okay.

And then I guess the other question for me winds up being, when you take a look at the balance sheet over the next couple of years, a lot of the sort of heavy lifting's been done.

I mean where -- is there any sort of opportunities out there for you guys to pick up anything over the next couple of years with rates bottoming yet again?

To me, that it such a tertiary mechanism or tool to utilize to help grow our earnings.

And I'm glad that you observed that, by and large, our efficiency around our balance sheet financing is -- has largely been realized.

There is another unsecured that has a high 4% coupon, I believe, in 2023.

But that's one that we, depending on where the interest rate environment is, we might take a look at taking out.

But that is such a tertiary consideration when I think about what are the drivers of AFFO per share growth.

But yes, I'm very happy.

Jonathan, are there any other points you would like to make?

Yes.

Well, I think when you look out over the next few years through 2023, we obviously took down the 2021s in January.

But in '23 and '24, we do have $1.7 billion of debt that's maturing.

The 2022s are 3.25%.

The 2023s are 4.65%.

And so knock on wood, if rates stay low, it's interesting that a 3.25% coupon today seems to be fairly high.

So we're always looking at liability management ideas.

We're always thinking about how the make-whole math kind of translates into a breakeven rate if we were to refinance certain pieces of the capital stack.

And you can expect us to continue doing that on a go-forward basis.

And does preferred have any place in the capital stack going forward?

We could issue in the mid- to high 4s today on the preferred side.

It's always something that we'll look at.

But when you look at the indicative cost for us of 30-year unsecured paper that's in the low 3 range today, that gap just doesn't make a lot of sense for us.

Our next question comes from the line of Brian Hawthorne with RBC Capital Markets.

How comfortable are you with your C-store exposure?

And how high would you be okay with it going?

We are very comfortable with the kind of tenants that we have exposure to that largely constitute our industry exposure.

7-Eleven, Couche-Tard under the Circle K banner, those are names that we are very comfortable with.

They are the best-in-class convenience store operators.

And we monitor their business, we have a very close relationship with them, and we are very comfortable there.

What we are not comfortable with are the smaller-format, kiosk-type C-stores that heavily rely on fuel sale to drive profitability.

And thankfully, those are largely out of our portfolio.

We do have some, but by and large, most of that 11% exposure is being driven by 7-Eleven and Circle K.

Okay.

And then have your tenants talked about rising wages impacting their coverages at all -- their coverage ratios?

We went through, how many, it was like north of 200 leases.

And the fact that -- I'm sure those conversations in every -- are not there in every tenant's conversations.

But I'm sure in some cases, those conversations had to have alluded to higher labor costs.

But by and large, we're happy to report that our tenants are doing fairly well.

And the fact that we were able to recapture 103% net of expiring rents leads one to believe that, at least the kinds of tenants that we have exposure to, are not insulated but are able to absorb the higher labor costs.

Our next question comes from the line of Spenser Allaway with Green Street Advisors.

In terms of the $12 billion of deals you guys sourced internationally this year, can you provide a little color on what particular property types or industries you were seeing most heavily marketed abroad?

It's largely grocers, it's C-stores, it's movie theaters, it's discount retail.

Those are the buckets that they would fall in as well as some industrial.

Okay.

And then just going back to the previous question on the recent wave of bankruptcies and ongoing headwinds in the retail segment, do you suspect that we could see CapEx eventually creep higher in the net lease segment just in terms of TIs or potential deferred CapEx on any vacant assets?

We saw the exact opposite.

Our CapEx has largely been consistent over the last 3 years.

And what has actually reduced was our property expenses.

If you notice, we were forecasting to the market that it would be anywhere between 1.5% to 1.75% and we ended up being at 1.4%.

And the reason -- there were 2 reasons for that.

One was that the property taxes that we were forecasting on our vacant assets was far more than what we actually realized, given that we were able to sell our vacant assets at very attractive total returns.

And obviously, the top line grew well in advance of what we had forecasted.

So those 2 factors resulted in the property expense margins coming in below 1.5%.

We are not seeing our CapEx numbers changing based on the current climate.

And I think it's largely due to the type of retail that we invest in.

It's net lease.

If it's working for the tenant, they are happy to invest the CapEx themselves, reposition the assets to continue to remain relevant and drive profitability out of the store.

And that's why the net lease industry tends to be a very, very efficient industry.

But again, it is absolutely a function of the client that one chooses to create an exposure to.

And if it's the wrong set of clients, I'd say, Spenser, that, that could have a different effect.

But on our portfolio, we're not seeing it.

Your next question comes from the line of Todd Stender with Wells Fargo.

Looking at the average lease term, it's now just over 9 years.

It's been edging lower, and you guys have certainly acknowledged that.

Can you talk about the recent re-leasing activity, maybe in the term that they're renewed for?

Your acquisitions have, on average, been higher than that average, but the portfolio average keeps drifting lower.

Maybe just talk about re-leasing, if you don't mind.

Yes, sure.

And this is something we've talked about in the past as well, Todd.

If you think about it, at least lease, the original lease tends to have a 15-year, 20-year or even 25-year sale/leaseback.

And then you have options built into these leases, and those options tend to be 5-year options.

And this is all disclosed in our supplemental.

If you look at our history of re-leasing, and we've done north of 3,000 leases, 80%, and it's been higher more recently, 80% to 90% of the existing tenants exercised these options.

And so when you reset the lease term, it's right around that 5-year time frame.

It's only when we are going out and re-tenanting it with a new tenant or finding a new tenant even with 0 vacancies that we have the opportunity to go beyond the 5 to something like a 10.

And those have averaged in the 6- to 7-year ZIP code.

And so if we were to do no acquisitions, I think the normalized run rate for a net lease company -- a very, very mature net lease company which is doing 0 acquisitions or very little as a percentage of their overall portfolio, the normalized weighted average lease term is going to be right around 6 to 7 years.

And that's where the asset management and real estate operations team comes into play.

And we have anticipated this and set the team up accordingly, and I think the results speak for themselves.

On a quarterly basis, we shared with you what the re-leasing spread is, and we shared with you what the capital invested was with regards to tenant incentives, et cetera.

And more often than not, they tend to be 0. And we've been capturing north of 100% of expiring rents, 103% this year.

It was a similar number last year.

And in this last quarter, it was 106%.

So I believe that we have a team that, in fact, could be viewed as somebody that could create value when these leases start to roll and we are able to maintain the kind of re-leasing activity that we have been able to achieve over the last 3 to 4 years.

That will become a growth driver for us.

But clearly, new acquisitions, one should expect, if it's a sale sale/leaseback, it should be in that 15- to 20-year ZIP code.

And if it's acquired leases, it's going to have double-digit numbers.

But as we become a bigger company, and unless our acquisition numbers don't keep up on a pro rata basis, the weighted average lease term is going to continue to sort of get lower and should normalize right around 7 years.

To that extension option number.

Okay, that's very helpful.

Our next question comes from the line of John Massocca with Ladenburg Thalmann.

So you mentioned kind of -- you mentioned in your prepared remarks that a significant, if I heard you correctly, a significant portion of expected 2020 disposition activity closed earlier this month.

Can you provide some color on what drove that?

Sure.

We are under an NDA, so I have to be very careful.

But it was one of our clients who did a strategic review of their real estate operations and approached us to buy back some of the assets that they had leased to us, or vice versa, that we had leased to them.

And it was a very attractive return.

We had 5 years left on the portfolio.

And we were able to transact with them.

And that closed, I believe, early part of last week, and it was to the tune of about $116 million.

So if you subtract out that $116 million in dispositions, you're back up to right around $108 million, and that's around the levels of what we achieved 2019.

Okay.

That makes sense.

Then as we kind of think about the dispositions outside of that transaction, how much, I guess, is potentially being driven by the CIM portfolio and maybe kind of fine-tuning that portfolio more to kind of what you guys want to hold long term?

Yes, this is a question that we've answered before when we had announced the CIM transaction.

This was a $1.2 billion transaction.

We had said that $1 billion worth of the assets that we purchased were ones that we would buy in the open market if they were available one-off.

There's about $200 million worth of assets that we are going to asset-manage more aggressively.

And by that, we had also bucketed that $200 million into -- some of them are going to be made available for immediate marketing, and that's about 25%, call it, plus/minus.

And the rest, we would collect the rent for as long as the tenant continues to pay rent.

And because of the location, because of the rent per square feet, we feel very good about being able to reposition those assets with potentially new tenants.

And so that would be the way that we underwrote the $200 million worth that would require more attention, if you will.

And that hasn't changed.

That's precisely the way we are thinking about the CIM portfolio.

Okay.

But then when you think about dispositions on kind of a net basis with that, let's say, $50 million that maybe is a little more immediately ready for repositioning within the CIM portfolio, it would seem to imply then, I guess, maybe a little less disposition activity versus what you guys accomplished this year.

Or is that the wrong way of thinking about it, and it should all be kind of blended together?

Yes, because are you guaranteeing me that you're going to be able to -- we'll be able to sell those $50 million this year in 2020?

We don't -- we didn't underwrite thinking that we were going to be able to sell 25% of that portfolio, the $200 million portfolio, in 2020.

So it is certainly a blend, John.

We would love to be able to achieve that.

And if we are, we might come back and say to you later on in the year that our disposition numbers may be north of what we have gone out with.

But there is certainly a level of flexibility that we've built into those disposition numbers.

Our next question comes from the line of Vikram Malhotra from Morgan Stanley.

Just on the -- going back to sort of the tenant health issues you referenced being really small.

Several -- on the restaurant side, there's several names that have cropped up: NPC, Krystal, et cetera.

I'm just wondering, maybe taking a step back, restaurants remain kind of part and parcel of the net lease business.

But are you thinking about restaurants slightly differently going forward, maybe on a 3-, 5-year basis, between public, private, franchisee, direct, corporate-owned?

Any specific segments?

Any color there would be useful just because we've seen a couple kind of crop up.

Sure, Vikram.

Thanks for your question.

We have -- and I'm not sharing anything new here.

We have been very cautious about the casual dining concept.

And more importantly, even if the concept is a good one, we have been very careful about exposing ourselves to small-scale franchisees.

And so those factors continue to remain front and center any time we are looking at transactions.

And largely what you see playing out in this -- in the restaurant space today is not unexpected.

And so we are very well -- thankfully, we are very well positioned for the worst outcome in some of what you have just shared, in terms of the names, and others that we are monitoring.

And in fact, our expected outcome on this very small exposure that we have is still going to be north of what we have underwritten in terms of our guidance.

It's my belief.

But our thinking has always been very cautious on the casual dining side.

It has been more positive on the quick-service restaurant side.

And even within the quick-service restaurants, there are other drivers such as franchisees need to have a certain number of units, they need to have a certain number of scale that would give us comfort, even if the corporate concept is one that we find very interesting.

So those hurdles have not changed.

Okay, great.

And sorry if I missed this, I dialed in late.

But on the international side, I heard you referenced a couple of categories you were exploring.

But just curious kind of how the pipeline looks between the U.K. and then just broadly, continental Europe.

Look, our focus is still very much the U.K. That's the geography that we decided to go into first for obvious reasons.

We feel very comfortable with that.

But we are starting to see some very interesting concepts coming out of Western Europe as well.

And we are doing our diligence.

Neil's making several trips across the pond to explore those opportunities.

So I'm not going to keep those off the table.

But in terms of the make-up, I think you should expect 20% of the volume, plus/minus, to come from the international market.

And I'd love to be surprised, and that's a challenge to Neil.

But the vast bulk of our acquisitions will still be U.S. domiciled.

Our next question comes from the line of Collin Mings from Raymond James.

First one for me.

Again, this is something that's been discussed on a few prior calls.

Obviously, a lot of competition out there for industrial assets.

Nothing closed during the quarter.

Can you maybe just update us on what you're seeing on that front?

And are -- maybe just talk a little bit more about the pipeline on that front going forward.

Yes.

Collin, the way you started asking the question is precise.

There's a lot of competition.

There are many people chasing single-tenant industrial assets.

And yes, we haven't been able to get any over the finish line in the last quarter.

We've been close on a few occasions but did not -- chose not to continue to pursue the aggressiveness on the cap rate side.

But it is something -- it's a product that we like.

It is an exposure to certain types of tenants that we would find as being very complementary to what we already have.

It's just that we haven't been able to actively get a lot of transactions over the finish line yet.

Okay.

And then I did want to follow up, actually, on a couple of questions on the deal flow on the international front.

You've referenced a couple of times, again, targeting plus or minus 20% of your activity in 2020 will fall into the international bucket.

So as you think about targeting, call it, rough numbers, $500 million or so of opportunities, just curious if you can maybe drill down a little bit more.

You've mentioned a few things in response to Spenser's question in terms of the different sectors or property types where you're seeing a lot of the deal flow.

Can you maybe just elaborate a little bit more on where you think you're going to be able to reach the closing table this year on some of those opportunities?

And then, just again, as you think about the relationships you've built in the region, just elaborate a little bit more on that as well.

Yes.

It's very difficult to tell precisely where within those different buckets are we going to end up.

Let's just look at historically what we have been able to achieved.

The large part of the 18 transactions that we -- 18 properties that we acquired, 17 were in the grocer -- were grocery stores, and they were with the Big 4 grocers in the U.K., and one happened to be a theater.

And so the bulk of the transactions that we are seeing is with the Big 4.

But there are some other transactions that we are starting to see that are very interesting.

And I'm not in a position to share with you names of tenants, et cetera, with whom we've -- we're making a lot of progress.

That is something, as you can understand, for competitive reasons, we'd like to get it over the finish line and then be in a position to talk about it more freely.

But our conversations is broader than the grocery industry is what I can share with you.

(Operator Instructions) Our next question comes from the line of Haendel St.

Juste from Mizuho.

So I'm not -- I don't know if I missed it, I don't think I did, but did you mention any update on the search for a new CFO?

And if you haven't, could you comment on where that search stands?

And what's embedded in the 2020 guidance from both the separation cost and the potential hiring of a new CFO?

Yes.

So look, we have hired a search firm, we have created a profile, and we are out in the market looking for the right individual to join the team.

That's where we are with regards to the CFO search.

The good news is Paul is very much here with us acting as a senior adviser and will continue to be with us through the end of March.

The fact that we have a very strong team with Jonathan Pong and Sean -- driving our capital markets and finance departments and Sean driving our accounting, we feel very comfortable that we don't have to be in a hurry to replace that particular role.

We have a very strong team.

Our focus is going to be in terms of finding the right person with the right cultural fit and can help be a partner to us in helping drive the next evolution of this company.

And we are not going to take an expeditious route to get there.

And we want to get this right.

With regards to your second question, or part of your question, is around severance.

It's just south of $2 million that is going to impact both the G&A as well as our FFO numbers.

And yes, I think those were your questions.

And as a follow-up of sorts, what level of international buildout cost is reflected in the current G&A guide?

And remind us again how many people have you committed currently or already to your international platform and where you'd envision that by year-end.

Yes.

So look, we already have a small office in London.

We have one person who is driving the business there.

We have outsourced a fair amount of the administrative work that is required, i.e., accounting, tax as well as legal.

It is quite possible, based on the analysis that we have done, that in-sourcing some of these functions may make sense.

If the growth in our portfolio continues or accelerates, the in-sourcing is going to accelerate.

So we are very comfortable with the controls that we have in place and the process that we have implemented.

And it's a structure that allows us to be incredibly flexible.

What we have committed to is to hire one other person in the U.K., but the number of people who eventually become part of Realty Income Limited will remain to be seen, and it's going to be partially driven by the size of the portfolio that we are able to create.

And so having that flexibility allows us to be much more nimble when it comes to the G&A load that is associated with the platform.

Got it.

Got it.

And then maybe one more, if you'll entertain me for a second.

Curious on -- or I guess, what your view is on -- if you feel credit, tenant credit being fairly valued in today's market and whether size is an advantage or maybe a disadvantage for maybe some of your smaller peers that have been able to grow faster in an environment where growth seems to have been prioritized over the past year or so.

Does that make you any more or less inclined to perhaps consider splitting the company maybe into a higher-credit and maybe lower-credit bucket or perhaps some transaction to, in effect, make the company a bit smaller?

Or any other strategic change on that front?

Look, that's a whole lot of questions that you've sort of built into this one question.

What I can tell you, Haendel, is we went through a very deep dive, I'd say, now about 16 months ago, 15 months ago.

And we feel very comfortable that our size, scale and cost of capital, first and foremost, is very portable and is a massive advantage to us as we have started to show.

We can do very large-scale sale/leaseback, and it does not create immediate tenant concentration issues for us.

We can be the one-stop shop for existing tenants and have transactions come to us without it -- without them feeling the need to have to go and test the market.

And that's value to them.

It's value to us.

It allows us to pursue proprietary software that we are developing in-house that is going to help us drive the life cycle of real estate within our business.

Those are things that comes because we have size and scale.

And we believe that we have created enough adjacent verticals and/or are exploring enough verticals where we will be able to provide a growth rate that is very comparable to all of our net lease peers.

And the fact that we have a lower cost of capital and the fact that we have scale and the fact that we have size, those are all benefits that should ultimately accrue to us.

So until that equation changes, I don't see us having to explore, what was it that you said, spin-offs or high-yielding or lower-yielding asset base.

I mean this is part of our underwriting.

And it's in fact the strength of our underwriting that allows us to pursue the full spectrum of credit tenants and opportunities.

And it's what helps us drive growth.

Our next question comes from the line of Christy McElroy from Citi.

It's Michael Bilerman here with Christy.

Sumit, I -- forget about a spin, but just thinking about disposition volumes, right?

Because on one hand, it would be highly dilutive relative to buying something with your cost of capital, being able to sell, you obviously sell an asset at a much higher cap rate than where you're effectively funding your costs.

So recognizing that there's some dilutive aspect of selling assets, I would have thought, just given your comments about how the market is pricing non-investment grade, given your size and scale of your portfolio, that you would be able to look for either industry, tenant or geographical, potential concerns where you may want to take a more aggressive approach at shrinking the base so that the additive things that you're doing, all these verticals that you're in, and having international and having your cost of capital from a debt and equity perspective, provides that much more bottom line growth over time.

And so that you're not going to be faced with something that comes down the road, 12 to 24 months.

I would just imagine, out of your portfolio, there's got to be more than $50 million or $75 million of dispositions that you'd want to do if you really took a hard look at the portfolio.

And we're constantly doing that, Michael.

We are constantly looking at the portfolio.

We're trying to figure out what is the best economic outcome.

Despite the fact that the cap rates seem very aggressive, what do we feel we can sell a given asset at versus holding on to that asset, collecting the lease and selling it vacant at the end?

That's an analysis that we are constantly doing.

The advantage that we have is so many of our assets -- and I talked about the Pier 1 example.

We did the sale/leaseback on those 12 assets that we own in 1998.

We can sell those assets for ground and come out with higher single-digit unlevered IRRs.

But the fact is their rent is current.

We are going to collect the rent.

And when they -- if they decide that they want to hand over some of the assets back to us, at that point, we could do the exact same thing that we can do today, but we'll have a few more months of rent collected.

So it really comes down to an economic argument.

And I think what differentiates us is we are constantly doing that on the assets that we have identified as not long-term holds.

And in some situations, we have decided that selling it today is absolutely the right economic outcome because the rent we are collecting, perhaps, is not enough to justify holding it till the rent stops coming in.

And that's where that $100 million, and in this year, $200 million, of disposition number comes in.

I think if you add up everything we've done over the last 6 years, it's north of $1 billion of assets that we have sold.

And it's not to avoid the dilution.

You're absolutely right.

That is a third-level, fourth-level consideration, but it's not the driver of the decision-making process.

It is really the economic analysis that we undertake, Michael.

Right.

But your company is 2x just over the last 5 years.

And you go above 10 years, it's 4x, right, just in terms of size of asset base.

I guess -- and I know the benefits of size and scale in terms of your cost of capital helping driving additional growth that allows you to do things, as you said, without getting a tenant concentration issue.

For others, they may not want to take off as much of a portfolio in a certain vertical because of that.

I guess I'm surprised that there isn't -- and look, maybe all the investments you've made have been great and you don't have a lot of issues.

I guess I'm just surprised that there isn't a more aggressive recycling of portfolio, especially in this environment where credit is being, I think, mispriced.

Yes.

Look, we'll continue to keep looking at it, Michael.

And who knows, maybe in a few years, we'll come out and -- or not even a few years, maybe in 12 months, we'll come out and say we may need to do more.

But right now, we feel fairly comfortable that I think we've -- based on the analysis that we've done, we're comfortable with the $200 million of dispositions.

Have your views changed on public-to-public M&A within the net lease space?

And sort of where is your mindset today, especially given your comments about size and scale and being bigger and being able to inherit other problems and dispose, or they're not as big of a problem for you as they are of the target?

We've always been open to M&A, Michael.

It's -- the question that we have wrestled with and the reason why we haven't been able to move forward has always been, do we have a seller out there that's willing to essentially sell their -- sell themselves?

And if that situation were to occur, we would absolutely engage in a conversation.

The question is -- you look around the net lease space today and you see all of the net lease companies are trading at very high multiples.

All of them seem to have a process identified to continue to grow their business.

Within that environment, do you see someone raising their hand and saying, "Look, we would like to engage." If that happens, we are not going to shy away from engaging in that conversation and pursuing M&A.

This concludes the question-and-answer portion of Realty Income's conference call.

I will now turn the call over to Sumit Roy for concluding remarks.

Thank you all for joining us today, and we look forward to seeing everyone at the upcoming conference.

Thank you, Kenzie.

Thank you.

This concludes today's conference call.

Thank you for your participation.

You may now disconnect.