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O Realty Income

Participants
Julie Hasselwander IR
Sumit Roy President and CEO
Christie Kelly EVP, CFO
Greg McGinniss Scotiabank
Katy McConnell Citi
Ronald Kamdem Morgan Stanley
Haendel St. Juste Mizuho Securities
Caitlin Burrows Goldman Sachs
Rob Stevenson Janney
Brent Dilts UBS
Wes Golladay Baird
Linda Tsai Jeffries
John Massocca Ladenburg Thalmann
Joshua Dennerlein Bank of America Merrill Lynch
Harsh Hemnani Green Street
Call transcript
Operator

Good day and thank you for standing by. Welcome to the Realty Income First Quarter 2021 Operating Results Conference Call. At this time all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised today's conference is being recorded. [Operator Instructions]. I would now hand the conference over to your speaker today, Julie Hasselwander, Investor Relations at Realty Income. Thank you. Please go ahead.

Julie Hasselwander

Thank you all for joining us today for Realty Income's quarter operating results conference call. Discussing our results will be Sumit Roy, President and Chief Executive Officer and Christie Kelly, Executive Vice President, Chief Financial Officer.

During this conference call, we will 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 cause such differences in the Company's form 10-Q.

We will be observing a two-question limit during the Q&A portion of the call-in order to give everyone the opportunity to participate.

If you would like to ask additional questions, you may reenter the queue. I will now turn the call over to our CEO, Sumit Roy.

Sumit Roy

Thanks, Julie. Welcome, everyone. The continued strength of our business is made possible by the incredible partnerships we have with all stakeholders. I would like to express my gratitude and appreciation to our Realty Income team who continues to effectively execute our strategic objectives while enduring a sustained, remote work environment.

As we've announced last week, we are excited to have reached a definitive merger agreement with VEREIT, which would further distance ourselves as a leader in the net lease industry and create a company with a combined enterprise value of approximately $50 billion. We believe shareholders of both companies will enjoy meaningful value creation through immediate earnings accretion and expanded platform with enhanced size, scale and diversification, driving further growth opportunities, and strategic and financing synergies which are enhanced by Realty Income's pay rated balance sheet and access to well-priced capital.

We are very excited about the strategic transaction and look forward to continuing to drive future growth together as a combined enterprise.

However, today we will focus on what was a very successful first quarter for Realty Income.

Our first quarter results illustrate our ability to grow through a variety of swim lanes afforded to us by our size and scale by completing over $1 billion in acquisitions. Notably, in this quarter, we invested approximately $403 million in high quality real estate in the UK, highlighting the continued strength of our international platform and bringing that total investment in the UK to over $2 billion since the first international acquisitions we closed in 2019. Domestically, we invested $625 million in real estate, including our first ever acquisition in Hawaii, becoming the first and only reason to own property in all US states.

Our accomplishments during the quarter continue to demonstrate the momentum in our business, and highlight our ability to leverage our size and scale to drive our business forward in pursuit of sustainable growth.

On the subject of sustainable growth, our team continues to make tremendous progress through our ESG initiative, as ESG considerations continue to permeate throughout our organization at every level. In April, we published our inaugural Sustainability Report, which details our company's commitments, goals and progress to-date with regard to environmental, social, and government initiatives. I invite all Realty Income stakeholders to share in our dedication to embrace the changing world for the benefit of all those we serve. And I encourage everyone listening to read our 2020 Sustainability Report found on the corporate responsibility page of our website.

Additionally, we are excited to share an updated investor presentation to the marketplace.

On the homepage of our website, you can find a new deck, which highlights our fundamental business philosophies, key competitive advantages, and plan for future growth.

Turning to results for the quarter, our global investment pipeline remains a significant driver of growth for our business.

Our business is simple. We seek to acquire high quality real estate lease to leading operators in economically resilient industries in pursuit of stable and increasing cash flow generation.

Our confidence in continuing to grow our platform stems from the quality of our real estate portfolio, which is designed for resiliency through a variety of economic environments. Key to mitigating economic risk, we believe in portfolio diversification by geography, client, industry and property time as we continue to grow our real estate portfolio. In the first quarter of 2021, we invested over $1 billion in high quality real estate and we remain very comfortable with our 2021 acquisition guidance of over $3.25 billion. On a total revenue basis, approximately 39% of total acquisitions during the quarter are leased to investment grade rated clients, which brings our total investment grade client exposure for the portfolio to approximately 50%. Aligning with our equals, the weighted average remaining lease term of the assets added to our portfolio during the quarter was 12.6 years. And at the end of the quarter, the weighted average lease term of our total portfolio was 8.9 years.

As at quarter end, our real estate portfolio includes over 600 clients who operate in 56 different industries. Approximately 84% of rental revenue comes from our traditional retail properties, while industrial properties generated about 11% of rental revenue. With regard to our retail business, we seek to invest in industries with a service non-discretionary and or low price point component of the business, as we believe these characteristics make for economically resilient operation that can more effectively compete with e-commerce.

As such of our acquisitions during the quarter, the largest industry represented were grocery stores. Walgreens remains our largest client at 5.5% of rental revenue, and convenience stores remain our largest industry at 12% of rental revenue.

Our investment philosophy primarily focuses on acquiring freestanding single unit commercial properties leased to best-in-class clients under long-term net lease agreements basically in excess of 10 years. We believe the market is efficient.

As such, we've seen a competitive environment for high quality assets leased to strong operators. Cap rates, as you all know, reflect an aggregation of many factors including but not limited to fundamental real estate economics, lease term, credit of the client or their sponsor, rent relative to the market, average rent coverage by the operator and alternative use of the real estate. Accordingly, the quality of our acquisitions is reflected in our average initial cash cap rate during the first quarter of 5.3%.

Our size and scale allow us to be highly selective in pursuing investment opportunities that fit our stringent criteria.

This quarter we sourced nearly $20 billion of transaction opportunities, ultimately investing in approximately 5% of the prospects sourced and reviewed.

Additionally, our cost of capital allows us to invest accretively even when pursuing the highest quality assets.

During the first quarter our investment spreads relative to our weighted average cost of capital were 115 basis points. The quality of the assets we acquire flows through the entire lifecycle of our portfolio, allowing us to basically recapture rent on expiring leases and maintain a healthy level of occupancy.

During the quarter, we re-leased 54 units, re-capturing 103.5% of expiring rent. Since our listing in 1994, we have executed over 3600 re-leases or sales on expiring leases, re-capturing over 100% of rent on those re-leased contracts, and occupancy at quarter end was 98%.

Our size and scale afford us the ability to execute large scale sale leaseback transactions which are often sourced through existing partnerships with best-in-class clients, but also serve as an attractive way to establish new relationships. The transaction we closed in Hawaii is an excellent example of the sale leaseback opportunities we can execute. In this instance, we partnered with car petroleum to acquire 22 well located convenience stores for approximately $116 million. All 22 properties fall under one triple net master lease agreement with an initial 15-year lease term. And all assets are located in many main locations, primarily on the island of O'ahu.

This quarter, about 24% of all acquisitions we close were executed as the leaseback transactions. The merger between Realty Income and VEREIT will enhance our ability to execute large scale leaseback transactions through expanded capacity to buy in bulk, which improve our competitive positioning when competing for portfolio or sale leaseback transactions in the fragmented net lease industry.

As we have previously articulated, the ability to buy at wholesale prices and at a discount to the one-off market is a competitive advantage.

We are often wanting a fully a handful of buyers for large scale portfolio transactions, particularly those that would otherwise create untenable client or industry concentration issues for our competitors. Proforma for the closing of the transaction, we will have approximately $2.5 billion of annualized rental revenue.

For every $1 billion of acquisition to a single creditor industry, our exposure to that creditor industry will increase by approximately 2% compared to around 3.5% based on our current size. By leveraging our size and scale, we continue to effectively execute through our international platform.

We have healthy acquisition volume in the UK. Fundamentally, we are replicating our U.S. business strategy, seeking to curate a high-quality real estate portfolio leased to leading operators in economically resilient industries.

Our total first quarter acquisition volume improved approximately $403 million of international acquisitions in the UK, which brings us total investment volume to more than $2 billion since the first transaction we closed in the UK in 2019.

Our International pipeline has accelerated even more quickly than originally anticipated.

This quarter's International acquisition volume represents nearly 40% of our total investment volume during the quarter. A figure that is truly incremental to the U.S. business and one that we expect to grow.

Now I'll pass it over to Christie to provide financial updates.

Christie Kelly

Thank you, Sumit. I'll start with some high-level background and then move into our financial results for the quarter. We're the only net lease REIT from the S&P 500, one of the top 10 largest U.S. REITs by enterprise value and the largest company in the net lease REIT sector. Upon closing our recently announced merger with VEREIT, Realty Income is expected to be the sixth largest REIT in the [ph] RMZ in terms of equity market capitalization.

Our size and scale, in conjunction with our conservative balance sheets and financial strength have afforded us to a credit rating by the major rating agencies and our $3 billion multi-currency revolver grants us ample access to well-priced capital that allows us to opportunistically raise permanent long-term capital when the markets are most favorable.

During the quarter, we raised approximately $670 million through an overnight equity offering to reduce our financing risk by pre-funding our active global investment pipeline. In January 2021, we completed the early redemption of all $950 million, 3.25% notes due in 2022 to take advantage of attractive borrowing rates in the fixed income market, while reducing our near-term financing risks. This redemption was primarily funded through our December issuance of $725 million of senior unsecured notes through a dual tranche offering of a five year and 12-year note, which achieved record low U.S. dollar coupon rates in the REIT sector for each of those tenors.

As a result, our fixed charge coverage ratio, I'm pleased to report, has hit an all-time high at 5.8 times this quarter. We believe funding our business with approximately two-thirds equity and one-third debt contributes to maintaining a conservative balance sheet. We ended the quarter with net debt-to-adjusted EBITDA ratio of 5.3 times or 5.2 times on a proforma basis, adjusting for the annualized impact of acquisitions and dispositions during the quarter. And our near-term debt maturities remain minimal, with only $26 million of debt maturing through year end 2021 excluding our commercial paper program and borrowings outstanding on our revolving credit facility. At the end of the first quarter, we had full availability of our $3 billion multicurrency revolving credit facility, $675 million outstanding under our $1 billion commercial paper program, and over $184 million of cash on hand, providing approximately $2.5 billion of liquidity available to capitalize on our active global investment pipeline.

During the quarter, our business generated $0.86 cents of AFFO per share and we are maintaining our 2021 AFFO per share guidance of $3.44 to $3.49 on a standalone Realty Income basis unadjusted for the expected merger. Remember, we currently have 37 of our 79 Theater assets on cash accounting. These 37 theaters represent about $25.5 million dollars of annual rent remaining in 2021. And we've reserved $33.2 million as allowance for bad debt on these assets, net of $1.9 million of straight-line rent receivables. In total, this $58.7 million translates to approximately $0.15 that is not currently included in AFFO per share guidance.

We are encouraged by the recent momentum in the theatre space, such as increased nationwide opening and the release of blockbuster films. Most recently, Godzilla versus Cong brought in approximately $49 million during the opening weekend, five days specifically Wednesday to Sunday, and generated more than $390 million in revenue within the first two weeks of its global release, turning a profit of more than $200 million.

However, until we are confident these particular theaters can continue to pay us contractual rent.

We will continue to recognize revenue for these 37 theatres on a cash basis.

As the monthly dividend company, we would be remiss not to discuss the dividends when providing business results. In April, we declared our 610th consecutive monthly dividends and we now increase the dividend 110 times since our listing in the New York Stock Exchange in 1994. Since 1994, we have increased the dividend every year growing dividends per share at a compound average annual growth rate of approximately 4.4%. And as a result of increasing the dividend every year for the past 25 consecutive years, we are proud to be a member of the exclusive S&P 500 Dividend Aristocrats Index which consists of only three REIT and 65 companies overall. I would now like to hand our call back to Sumit.

Sumit Roy

Thank you, Christie.

Our first quarter results continue to highlight the incredible opportunities afforded to us by our size and scale, which uniquely position us to be the global consolidator in a highly fragmented net leased space. And we believe the very merger will enhance our positioning to be just that.

Our positive results as well as our powerful business momentum and in strong outlook energize our talented team to continue expanding our existing verticals, while finding new swim lanes through which the business can grow. At this time, I'd like to open it up for questions. Operator?

Operator

[Operator Instructions] Your first question comes from Greg McGinniss from Scotiabank.

Greg McGinniss

Hey Sumit. The very acquisition dramatically increased your exposure to casual dining tenants to 7% of ADR, which is an industry where other rates seem to be limiting exposure. What makes you comfortable with acquiring all those tenants?

Sumit Roy

That's certainly an area that we spent a fair amount of time focusing on Greg, when we were looking at VEREIT. The biggest contributor to that 7% is Red Lobster. And looking at where Red Lobster is today versus even where it was a year ago, gave us a fair amount of confidence that Red Lobster has turned the corner from being privately equity owned to being owned by a company out of Thailand Thai Union. And the credit enhancements that it achieved, the results that it is now posting, the fact that it gave --that it paid 100% of the rent in the fourth quarter to VEREIT.

All of that gave us confidence that it's turned the corner and being vertically integrated organization, such as Thai Union is made us feel like 7% of the number that we can live with. But the goal here Greg will be over time to continue to reduce that, just like we did with our casual dining concept which used to be in the high single digits. And today represent less than 3% of our overall registered. And that will be the goal with on a proforma basis being up to 7% continuing to reduce that back down into the low single digits.

Greg McGinniss

Okay, thank you.

Second question, given less concern about tenant concentration issues following the very merger, are there portfolios in the marketplace today that you now feel more comfortable pursuing? Are those types of portfolios already considered in acquisition guidance? And then how much volume do you think those types of portfolios could potentially contribute to acquisition each year?

Sumit Roy

Yeah, there's a bunch of questions you've asked there, Greg. The question is, we've talked about how proforma for this acquisition, it allows us to pursue larger transactions. I will say that you don't have multibillion dollar transactions coming in every week. But when you do, they can be a step growth, opportunity, just like a consolidation is in our industry. But given our size today, doing a multibillion-dollar transaction, we were somewhat constrained, pursuing that even if it checked all the other boxes, i.e. we like the credit, we like the operator, we like the industry, we like the makeup of the real estate, we like to rent composition, et cetera, et cetera.

You feel constrained, just given how much of your portfolio concentration gets impacted by a single tenant. But once you start to increase your platform, the ability to absorb larger transactions, when they present themselves, certainly enhances. And there have been opportunities and I don't want to get into details, when even in the past 12 months, there have been opportunities to pursue transactions, where given, everything that we have relationship, to check the boxes across the spectrum we were still constrained by the allocation that we had to be able to pursue this particular transaction single handedly. And those are the types of constraints that do get elevated, the larger your platform becomes. And it does allow you to be able to present yourself as a one stop shop for some of these very well capitalized businesses that you want to continue to be their one stop shop, which we have been in this one example that I'm referencing.

So, yeah, I do think that, post this consolidation, that it will enhance our position to pursue transactions that we were, somewhat constrained to do so in our current size and scale.

Greg McGinniss

Thanks, Sumit.

Operator

Your next question comes from Katy McConnell from Citi.

Katy McConnell

Hi there.

Sumit Roy

Hi Katy.

Katy McConnell

Could you update us on the portfolio of office assets that you plan to spin off with the merger? And now that the deals out in the open what have you been able to gauge as far as buyer interest in your ability to potentially sell those off instead?

Sumit Roy

Kate, it's been three business days since we made the announcement. But thank you for asking the question. Yeah, look, we've been pleasantly surprised by the inbounds. We're still in the process of collecting those inbounds and trying to figure out what's real from what's not true? We have been very clear that the path that we control is the spin off path. To answer your question more directly, it's essentially all of our office assets along with the vast majority of the of the VEREIT office assets outside of the six assets that are constrained by a CMBS pool, which is cross collateralized across multiple asset types.

So outside of the six, our goal would be to basically spin off all of the remaining assets, which is right around 97 properties, $182 million $183 million in rent, weighted average lease from circa 4, 76% 77% investment grade tenants. That's the makeup of the portfolio. But as we had thought would happen, once we announced there have been inbound calls, we are just gathering the information, but it is still too early to tell what's real from what's not.

We are going to continue down the path that we control. And if something were to happen in the meantime, that's great. But it's too early to tell.

Katy McConnell

Okay I appreciate that color. And then can you talk a little more about the decision to just enter the Hawaii market now? And whether you all want to increase the scale there more meaningfully or potentially pursue any industrial opportunities there?

Sumit Roy

Yeah, Katy, it's just, it's not something we intentionally pursued in this particular quarter. We've always, two CEOs ago, Tom was from Hawaii. And the inside joke was how come we don't have any properties there.

Now, Jonathan Png is our resident Hawaiian. And the joke has continued, but it really was the function of the bright opportunity presenting itself at the right time with a partner that we liked, we underwrote their business, we underwrote their performance, we underwrote their locations, it was just the right time at the right place. And it just so happened that it closed in the first quarter. There wasn't any grand design to be able to come out and make the kinds of announcements that we have done. We've been very opportunistic, very lucky in some ways, and very grateful to now be able to say that we are in 50 states, but that to us was not as important as finding the right transaction. And this particular transaction that allowed us to go to Hawaii certainly checks all the boxes.

So, we're very grateful for that.

Katy McConnell

Okay, great, thank you.

Operator

Your next question comes from Ronald Kamdem from Morgan Stanley.

Ronald Kamdem

Hey, good afternoon, just two quick ones for me.

The first is just on tenant's health in general on the portfolio. Maybe if you could provide some updated thoughts on how you're feeling today, maybe verses six and 12 months ago? And then digging in a little bit deeper into some of the theaters and looking at the collection rates there, maybe some insights as the collection rate may have been a little bit lower than what we would have expected. Maybe what's going on there with theaters?

Sumit Roy

Sure, Ronald, thank you for your question. Look, our watch list is right around 5%. And it's the biggest contributor to that watch list is the theater business.

So, they are very much tied. And our collection is also largely a function of the collection in the theater business. We feel you asked me to give you a reference point as to how we feel about a theatre business today versus when we first got into the pandemic, we feel a lot better today than we did then. There have been actual examples here in the U.S., which were preceded by examples playing out in China and in Japan, which lend credence to the hypothesis that we had, that the theater business once the contents was starting to get released and the social distancing norms were relaxed, the theater business was going to be able to bounce back. That piece has largely proven out to be the case, Ronald. I mean, if you look at the only one example that we currently have of a big blockbuster movie that came out, which was the Godzilla versus Kong. In the first five days, it generated right around $49 million. We've been tracking how it has done subsequent to that as well. And it's right in that high 80 right around $90 million is the collection here in the U.S. theaters.

If you look at it globally, it's close to $390 million. And the budget to make that movie was right around $180 million $190 million.

So, $200 million roughly largely being gathered through the theater release. And that just continues to lay credence to that as content starts to come in, as these theaters are allowed to open, AMC is largely open here in the U.S. Regal is still not. Regal is still targeting mid to late May, to open up all of its theaters.

And so, we do believe that this connection is going to become a function of the theaters opening. And based on the discussions that we've had with our operators, we continue to feel very optimistic that in the near term, those collection numbers will start to go up. But look, we're also blessed with a balance sheet, to lend grace to some of these operators, as long as we believe that their operating model is going to come through and it's going to be a viable business model going forward. And we genuinely believe that the theatre industry, and specifically these two operators are going to be viable operators going forward.

And so, if we have the ability to lend our balance sheet, give them a little bit more grace, in terms of stabilizing their operating business model, that's what we've done. And we feel very good about that decision.

Christie Kelly

And Ronald, this is Christie. The only thing I would add to Sumit's comments is just a reminder to the team that's on the line is that, our theater portfolio is really high quality. There's over 80% of the theaters in our portfolio that are in the top two core piles of each of the operator's footprint. And as Sumit mentioned AMC is open, but it limited capacity right now and Regal Theaters will be opening towards the end of May. And to that point, we're cautiously remain cautiously optimistic. But there's one thing I want to point out that, when we take a look at the momentum, as it relates to the collection rate in theaters, it's steady and improving.

So, stabilize from year end, we were about 10% collection and then throughout the quarter, we've gained some momentum to build towards 16%.

And so, we'll look forward to recording more when we come to the second quarter.

Ronald Kamdem

Great, that's helpful. My second question was just going back to the VEREIT merger. This may be just a simple question but just can you help us understand how your real estate the quality of your real estate, the quality of the retail assets that you own compares to those of VEREIT that you're going to be taking in, right? How should investor think about comparing and contrasting the quality of those portfolios, specifically, the retail piece? Thanks.

Sumit Roy

Yeah, Ronald we've got 3500 properties that has been constructed over the last 11 years, since they became public. Clearly there are areas of the portfolio, one of which we touched on, has turned the corner. But it wasn't something that we would have pursued in isolation six years ago when they when they chose to do that transaction. But by and large, I would say we were pleasantly surprised when we underwrote all of their assets, all of their operators at the quality of the portfolio they had, and there was an art to be making, for whatever reason, and we're grateful, because it allowed us to create a lot of value for our business, that they were trading at a massive discount to what we believe is the inherent value, especially of their retail and industrial portfolio.

And so, the other point I would like to highlight is the fact that they are complementary to our focus. This is why, things like convenience stores which we are big fans of with certain operators I want to qualify allows us to go from 12% to 9% proforma for the combination. It allows us to take our grocery from 10% to 8%, because they don't have those allocations in their portfolio.

And so that certainly helps us create additional capacity plus on the theater business, they didn't have much of an exposure.

So that allows us to bring down our theater exposure from 5.7% 5.6% to 3.8%, which is starting to get closer to the optimal adaptation that we have been talking about over the last couple of quarters.

So, pleasantly surprised on the upside, which is one of the main reasons why we decided to move forward. And we're so grateful that we found a like-minded person and Glenn and his management team to move forward with a transaction that we genuinely believe is a win-win for both parties.

So, yeah, super happy to absorb that retail and industrial portfolio into the proforma Realty Income business.

Ronald Kamdem

Super helpful. Thank you.

Operator

Your next question comes from Haendel St.

Juste from Mizuho.

Haendel St. Juste

Hey, good afternoon out there.

Sumit Roy

Hi Haendel.

Haendel St. Juste

Can you talk about the - hello? Can you guys talk about the acquisition capital a bit more in the first quarter the low 5% of all 4.9% in UK? I believe last quarter, you suggested that cap rates would be - for this year would get back, would be similar to 2020 levels, they are closer to maybe 6% depending on mix? I understand you're seeing increased competition. We've heard of financial buyers getting 85% 90% LTV financing ABS market.

So maybe, can you talk about the market and what roll that competition out from potential buyers? Is this playing on the pricing for the assets that you're looking at? And is it specific to any sub sector industry and if this low 5% cap rate is what we should expect in 2021?

Sumit Roy

Yeah.

So, Haendel quarter-over-quarter these numbers are going to vary and it is largely a function of the mix.

If you're going to be heavily industrial focus, the cap rates are going to be on the lower end.

If you're going to be more retail focus, it will be on the higher end. I'm making general comments. Obviously, there are exceptions to even to what I just said. But if you look at what drove the UK cap rate, it was largely two industrial transactions that we did with the same seller that we have a very good relationship with. One was an industrial asset in the Greater London area, highly sought clearly a last mile location and we got it at a cap rate we felt very comfortable owning this particular asset.

Another one was in the suburbs of Birmingham; you know that it's leased to a single a credit. Again, fantastic distribution center below market rents.

Something that we feel like is going to be super additive to our portfolio going forward. And that's what really drove the cap rate to where it was. Had we excluded those two, our cap rate would have been closer to where we did our fourth quarter UK transactions, which was, I believe, if I remember correctly, 5.6 5.7 cap rate.

So, it really is going to be a function of mix, it's going to be a function of which geography dominates, et cetera, et cetera. But I don't think you should expect the cap rate we posted in the first quarter to be the new norm. I would still say that we should average right in that mid 5s to do slightly above that, that would be the goal. And in quarters where we do some more higher yielding stocks, because it's things that we found that the people are not focused on yet, we could see a potential 6. But it really is going to be a function of a mix, it's going to be a function of asset type, lease term, geography, all of those things that go into defining what a quarter cap rate signifies. But I think the bigger point here is, this is the second quarter in a row where we've done a billion dollars. And I've seen a lot of numbers coming out talking about Oh, in order for them to get to the high single digit growth rate, they're going to have to do $4 billion of acquisition. We welcome that challenge.

In fact, we are excited about that challenge. And we've already talked about what creating these new verticals for us, new markets growth for us has done to our sourcing numbers, which is not translating into actual [ph] clothes.

So, for us, the numbers being posted, yes, for most net lease businesses that's a staggering number. But for us, it's something that we welcome, and we also agree with the market that it is for us to show to you that we are capable of doing this on a quarter after quarter after quarter basis.

So that's where the fun part is for us and the team. We look forward to that challenge. And we look forward to posting numbers with assets that doesn't compromise what we have said is our risk profile. And that's the key message here, that we are doing all of this. And we are growing our platform and we are growing our portfolio with the right type of industries, right operators, right geographies, right growth rates, all of the things that we create sustained value over the long term.

So, I know you didn't quite ask that. But I just wanted to make sure that we output the answer on cap rates in context to what it is that we are trying to do. And the sustainability of what it is that we're trying to do.

So, forgive me for that Haendel.

Haendel St. Juste

No. That's perfect. Thank you for the color, I certainly appreciate it. Can you also talk a bit perhaps, are you a bit more willing today at all to consider industries that you perhaps put off to the side over the past year in the aftermath of COVID? Perhaps, expanding your investment playbook here, be automotive more entertainment or experiential things that have been a bit less COVID resilient, but given the improving vaccine distribution as the economic expansion, just curious if that view is changing at all, and if there's any specific industries reflect to?

Sumit Roy

Haendel, one of the things that will distinguish this team, I think, and I believe in, is the fact that we will always remain humble. If data is changing on the ground, if trends are changing, we're constantly trying to mark the market. But what we don't want to do is over index to any near-term phenomenon, just like we didn't over index to the fact that, hey, the theater business and the health and fitness business really took a took a beating in an environment where you have social distancing requirements. And does that mean we should go down to zero in both those businesses? The answer is no.

And so, what we are trying to figure out is, what are the trends, especially given the long-term nature of the leases that we enter into, what is the trend long term that we are going to underwrite to? And just because something creates a potential opportunity near term, if we can't get comfortable with the long-term prospects, we will largely stay away from those types of situations.

Now that doesn't mean we don't get a few things wrong. And in hindsight, we don't go back saying Oh, we should have made that a different way, because our conclusion was inaccurate. But we, I believe, have gotten more things right than wrong. And that has served us well.

So, the answer to your question is, without getting into specifics that we are constantly trying to upgrade our pieces to reflect what's on the ground. But we don't try to over index to it without taking into consideration with the long-term impacts of those immediate trends that we're seeing. I'll throw something out there, which is the exact opposite of what you're suggesting.

I think there is an opportunity in the office sector.

Now, are we going to go into the office sector? No, there's a reason why we said we are going to be spinning off all of our office assets. But I do believe that given the environment today, and given how negative the sentiment is around the office asset type, there is value to be had. If somebody is willing to take a longer-term perspective on what is office going to look like. And that's the reason why we want to create a spin off if that is the route, we end up eventually evacuating. We want to set it up for success. And it is a play on what we have seen near term. And then it's forecasting out that trendline to see what do you think it's going to happen to Office five, seven, 10 years from now? Where do we see growth? Yes, growth? I use that word with Office. Where do we see opportunities? And, there is an argument to be made that that could play out so Time will tell.

Haendel St. Juste

Any perspective you want to share on the casinos? I know it's been asked in the past. But I'm curious is that view and that subsector is any different or any more willingness today to act on that?

Sumit Roy

Yeah, I'm not going to talk about specifics Haendel. And you've always asked me very specific questions, and I've tried to stay away from it.

You asked me about M&A. And I did M&A for you now. No, no, stay away from specifics Haendel. Thank you though.

Haendel St. Juste

Appreciate the time.

Operator

Your next question comes from Caitlin Burrows from Goldman Sachs.

Caitlin Burrows

Hi, guys, hi there. Sumit, you gave some details to explain the relatively lower cap rate in the UK this quarter. But there's also the associated tax burden in the UK which impacted numbers in the quarter.

So, I was just wondering, kind of big picture if you could go through why the UK investment activity makes sense to you bigger picture and then also how we should think about the associated tax expense going forward?

Sumit Roy

Yes, very good questions, Caitlin. Thank you. I should have actually completed my answer on the UK, giving a little bit more color on the structuring side of the equation.

So, we went into the UK recognizing that there's going to be an associated track tax leakage. And when we underwrite transactions, we take into account what is our effective tax rate? What is the statutory tax rate? What's the effective tax rate? How much are we really making in terms of actual spreads, et cetera, et cetera. And of course, comparing it to the cost of capital, which is also much lower in the UK. And seeing if it's if it made sense. It made a lot of sense. And by and large, I think we are tracking to the effective tax rates that we had shared with the market two years ago in April of 2019. What I would like to add Caitlin is, there is a change that is being contemplated, that would actually increase the statutory tax rate in the UK market. But what we have been exploring and hopefully we'll be able to implement in the near term is restructuring our Realty Income limited the legal entity that that is house there where we will actually end up potentially saving 400 basis points off of our effective tax rate.

So, do you expect to see this this the taxes being paid in the UK continuing to go up? Absolutely, you should. But not at the same rate as you have seen over the last three years.

We are getting more efficient.

We are structuring our transactions going forward in a manner where we are actually going to see on an effective basis and decrease in the tax leakage associated with our investments. And we are constantly looking at how we're going to be financing this transaction, and does it still make sense? And the answer is a resounding yes, it does. And that's the reason why we're continuing to do what we're doing.

Caitlin Burrows

Got it.

Okay. And then maybe switching topics, the guidance that you guys have put out assumes that same store revenue improves as the year goes on. There was commentary earlier on hopefully improving theater collections and performance and acquisitions are expected to continue. But the AFFO guidance kind of barely implies any growth from the 1Q run rate.

So, I was just wondering, why is that? How does the improving same store revenues and acquisitions not translate into more meaningful AFFO for the guidance or is the AFFO guidance just pretty conservative at this point?

Sumit Roy

That's an opinion. I'll let you conclude that for yourself, but I do think Christie mentioned as to the 37 assets that are on cash accounting, so, so much of the improvement that could play out in the future has not been sort of reflected in the guidance that we have shown, but nor have we changed our cash accounting on those 37 assets.

So, we really, if you want to use the word conservative, fine, we just really want to see actual collections go back up to levels that warrant a change in our thesis around cash accounting versus not. And then that would certainly translate to higher AFFO per share trend lines. But we tend to be a little bit more deliberate. And, yes, things are looking very optimistic. But until it's not actually starting to reflect in enclosed monthly statements, we're going to stay the course. And, obviously, what we have and the reason why we haven't adjusted is for the merger is because first and foremost, there are conditions involved. And even if this were to close, it won't happen to the fourth quarter, which clearly will have a very minimal impact this year.

And so, for those reasons, we have kept the guidance, exactly the same. We want to digest what we just announced last week.

We also want to get another quarter under our belt, and then we revisit earnings at the end of the second quarter. And share with you what our latest thoughts are on that.

Caitlin Burrows

Okay, thank you.

Christie Kelly

Thanks, Caitlin.

Operator

Your next question comes from Rob Stevenson from Janney.

Rob Stevenson

Good afternoon.

You guys currently have as of March 31, 131 vacant assets and presumably you'll have additional assets become vacant over the remainder of the year. Ordinarily, some percentage of that you guys keep and release and some you sell and move on.

Given the size of the very transaction of the integration process, how do you guys think about your team's bandwidth and maybe just selling a greater percentage of the vacant assets that they can't be released easily and moving on, and focusing on the integration versus the time energy and even the potential upside from re-leasing vacancy?

Sumit Roy

We are very comfortable executing exactly the same business model that we have.

We have always said that, if you want to run a business 100% occupancy we can. But that is not value optimizing solution. And the reason why we have also shared with the market, our real estate operations team as is the largest in the company is to be able to do the things that we want to do. That is the reason why we have always said that 98% is the right occupancy level for us because we are going to be repositioning assets where we can create, and these numbers get buried, but 140% 170% recapture rates on rent just because of these repositioning that we are able to do but yes, it takes time and yes, that means more, you're sitting on more non-occupied assets. But we are very comfortable doing that, if that is the right economic solution to do so. And just to put things in perspective, that 131 was 140 at the end of the fourth quarter, because we got 65 of our NPC assets back. And the team was able to not only absorb the first quarter explorations, but make a dent and a pretty good one on those assets that were handed back in the NPC transaction. I am super comfortable with the team that we have and the asset management team that is led by TJ, they are a phenomenal group. And what we would like to be able to do is when we absorb VEREIT, is to be able to implement the same business model, which is a reason why we think we want to hold on to a lot of their folks and potentially share our business model with them, and tried to generate the same types of results that we've been able to generate on a standalone basis. That is another area that we can enhance through this combination.

Rob Stevenson

Okay. And then second question, how are you thinking about [Indiscernible] going forward? It's been mostly non-retail as of late. And even overall, it's a pretty small piece of O today about to get much smaller with the acquisition? Do you need to keep that to fulfill obligations to the customers? Does that go away? How should we be thinking? Does that - Is there a chance that that gets bigger going forward for you guys?

Sumit Roy

Rob, I missed the key word, because there was a big beep. What is it that you said that we need to keep forward? And it's a very small part of our business?

Rob Stevenson

The development business.

Sumit Roy

It's that. Yeah.

Rob Stevenson

It's mostly non-retail, and it's really even overall, a really small piece of O today, going to get much smaller. Do you grow that? Does that need to stay because of commitments to customers et cetera? How are you thinking about that business?

Sumit Roy

Very good question. We hope to grow that business. It's about a $200 million business today. And you're absolutely right, that's not very large compared to the balance sheet that we have. But, some of the repositioning's I alluded to, some of the relationships that we have with existing industrial clients who want expansion capabilities, some of the relationships that we are developing with developers to provide a capital source, that could be a takeout, all of that is incredibly valuable to us. And I would love to see with a bigger platform, make this 3X 4X or what it is today, and being another contributor of value to our business.

And so, we have a team that we have continued to grow, and through this combination, we will potentially grow this team even more, so that we can continue to enhance value going forward, even while just working on our own existing assets. And going back to your previous question working on vacant assets or soon to be vacant assets, and doing repositioning. That requires an enhanced expertise in the development front.

So, we will certainly hold on to it and grow it. And potentially grow the allocation from where it is today.

Rob Stevenson

Okay, thanks, guys. Appreciate it.

Christie Kelly

Thanks Rob.

Operator

Your next question comes from Brent Dilts from UBS.

Brent Dilts

Hey guys.

Just Sumit, following up on your -

Christie Kelly

Hi Brent.

Brent Dilts

Hey, Christine, how are you?

Christie Kelly

Good. How are you, Brent?

Brent Dilts

Doing great. Sumit, just following up on your comment earlier about the $4 billion in acquisitions. This year that you've seen some analysts write about I'm just curious, are you seeing anything in the market that could call the slowdown in the pace of your transaction activity in the near term? Just seems like you're on pace to well exceed the minimum 3.25 you guys got to do.

So, I'm just curious what you're seeing there?

Sumit Roy

Brent we are very optimistic. We, to be very honest with you, we are not seeing anything, we are obviously following some of the same rules coming out of DC and how it is going to have an impact et cetera.

We are not seeing any of that translate into the volume being sourced. And our belief in not only meeting but potentially exceeding what we have shared with the market as our acquisition target. We started the year. And I think, Brent, if you recall, when we came into January, we shared with you what our pipeline looks like and how optimistic we were, that optimism has just continued to grow.

So, we are super excited about not just the sheer volume but the quality that we are seeing and the quality that we are being able to get over the finish line.

So, the platform is working.

Brent Dilts

Okay, perfect. And then just digging into the transaction activity a little bit more. Could you talk about what you're seeing for some of the trouble tenant asset classes as reopening plays out and rent collection rates there improve. Are you seeing any of those assets starting to trade health and fitness, movie theaters, et cetera?

Sumit Roy

Sure. We've certainly seen a couple of trades on the health and fitness side, especially with the more established operators. We've seen a few vacant assets on the theater side sell.

So yes, people are getting much more optimistic about the future and are willing to buy vacant pieces of land with a building and reposition it. And that optimism is starting to filter in into the acquisition arena. But that's not an area that we play in. But it's certainly it's certainly something that's seen.

Brent Dilts

Okay. Thank you. Sure.

Operator

Your next question comes from Wes Golladay from Baird.

Wes Golladay

Hi, everyone.

Sort of a few quick questions for you. Hi there, Christie.

Looking at the industrial same store revenue, looks like it's been negative 40 basis points last year, and it continued into this year. Do you expect that to reflect later this year?

Sumit Roy

Yeah, Wes, it's largely driven by this one asset that we had incorrectly calculated the CPI adjustment to it. And when we realized our mistake, and of course, we had collected rent on that. We went back to our clients and we shared with them that look, there was a mistake. And we gave them all - we readjusted the rent going forward. And that's really what you're starting to see play out.

And so, obviously the client was incredibly happy about us coming out and sharing this information. But that's really what you're seeing play out.

If you look at the actual leases on the industrial front, they have a lot more growth built into it than even our retail leases doing.

So, the same store rent numbers should actually on a normalized basis, whereas I would expect it to go up. Not down.

Wes Golladay

Gotcha. And then, made this early but I was curious about the potential office spin off how the capital structure would look and what that would mean for O's proforma leverage?

Sumit Roy

We are absolutely focused on maintaining our A three A minus rating. And I believe the rating agencies came out and reestablished, the ratings as well as the outlook post the announcement, we made last week and we are very much focused that proforma for the spend, we will continue to maintain ratings because even proforma for the spend, the proforma company is going to be close to $50 billion in size. And we'll have leverage metrics that is equivalent, if not better than what where we are today.

So, it is super important for us to maintain our ratings.

Wes Golladay

Got it. Thank you. Well.

Operator

Your next question comes from Linda Tsai from Jeffries.

Christie Kelly

Hi Linda.

Linda Tsai

Hello, Christie. Hi, Sumit. Maybe following up on your earlier comment that you can handle and welcome large acquisition volumes.

For this quarter you sourced $20 billion and invested in 5%. Does this 5% or $1 billion executed to $20 billion sourced ratio remain consistent post-merger?

Sumit Roy

I hope it gets enhanced.

I think I said this last week, and does that where VEREIT has been spending a fair amount of their time is not exactly 100% of an overlap of where we spend our time.

So, we would like to be able to continue to leverage their platform and their ability to play in a zip code that we haven't spent a lot of time because, we're finding plenty of opportunities in the areas that we would really want to focus on.

So, my hope is that pro forma for the combination, that the platform will increase in size and the area of focus will increase. And therefore, we might be able to create a trend line that is a step up from where we are today. But that is down the road. I want to stay focus on where we are today and the platform that we have currently. And if you look at the ratio of what gets closed versus what gets source, we have generally been in this 4% to 7%to 8% zip code for many quarters now. I mean, have there been quarters where those numbers may have been higher or slightly lower, perhaps, but it's generally in the zip code and we have the infrastructure to absolutely deal with that volume, and deal with getting our share of that volume over the finish line. And we haven't remained stagnant. That's the other point. I know, that's not very obvious from the outside, our team has grown.

We have a complete platform now in the UK, which is in addition to the platform that we have in the U.S., which didn't exist.

So, the platform has continued to grow, to absorb this higher volume of analysis that that is being asked of this team.

So, so far, so good.

Linda Tsai

Thanks. And then my second question is with G&A at about 4.5%. Do you have a sense of how low this could go maybe a few years out post-merger?

Sumit Roy

We talked about the G&A synergies in that $45 million to $50 million, and a cash synergy is in 35 to 40.

I think there's some analysis that the team has done, where we show you that the journey to gross asset value potentially drops by one-third, going from 33 basis points to 23 basis points or 22 basis points. And, that is the goal. We absolutely believe in that, that the larger our platform becomes, the more scalable it is, and therefore it should translate to G&A numbers continuing to go down. But how far down does it go? I can't tell you. It's also going to be a function of, do we continue to add new swim lanes? If we do, we need the infrastructure to help support that. And if it keeps our G&A elevated, because we're still not reaching this normalized level of what this business and platform is capable of doing, I'm totally fine having a G&A in the course. But on a normalized level. If we have exhausted all possible swim lanes, then who knows that this thing can go? I don't have a precise answer for your Linda.

Linda Tsai

Thank you.

Operator

Your next question comes from John Massocca from Ladenburg Thalmann.

Christie Kelly

Hey, John.

John Massocca

Good afternoon. How's it going?

Sumit Roy

Good. How are you?

John Massocca

Just a quick one from me, outside of office, how much roughly speaking of the VEREIT portfolio do you view as being a target for capital recycling as you look to manage the portfolio?

Sumit Roy

I think I've answered this question in a different way, in terms of how much did we like the industrial and the retail portfolio that will be part of remain comp [ph] going forward? We don't see their makeup being largely different from ours, except in the areas that they've chosen to focus on. But the more we underwrote those industries and the actual operators that they have exposure to, the more comfortable we got that overall, this portfolio is one that we will be very proud to absorb.

So, John, I don't have a precise answer. Could you see a corresponding increase in our capital recycling that we managed through disposition? You could, but that would be more of a function of the size of the platform has just increased rather than it getting disproportionately larger, because there's a lot more assets on their side that we would want to recycle that. Time will tell, but I suspect that it will be commensurate with what we are established as a standalone company today.

John Massocca

Okay. All my other questions have been answered.

So that's it for me. Thank you.

Sumit Roy

Thank you, John.

Operator

Your next question comes from Joshua Dennerlein from Bank of America.

Christie Kelly

Hey, Josh.

Joshua Dennerlein

Hey Christie, hope you're doing well. Curious how you think about Europe now that you're a larger entity, just split the $2 billion mark over in UK. Are you thinking of kind of accelerating one of the portions to the rest of Europe at this time, or there are some other hurdles that you do look into [Indiscernible]?

Sumit Roy

You know, Josh, that's a very good question. And I do want to answer it. What we were planning on doing on a standalone basis has absolutely not changed because of the announcement we made last week. I don't believe that it accelerates our desire to go into the rest of Europe, just because of this particular merger.

Our desire to go to other geographies and other markets are largely being driven by our underwriting, our ability to absorb new markets, the team that we have in place, the maturity of our understanding of these various different markets. That's what's driving our desires.

And so, yes, could we do more because the scale benefits of absorbing $15 billion platform? The answer is absolutely, yes. We can do more.

And so, I think that's where the benefit comes. But I don't think, trying new things is triggered by the fact that we have a large platform off of which to try it.

So, I just wanted to make that nuanced point, Josh. But it was a great question. And I'm glad you asked.

Joshua Dennerlein

Great, I appreciate it. That's it from me.

Sumit Roy

Thank you, Josh.

Operator

[Operator Instructions].

Your next question comes from Harsh Hemnani from Green Street.

Christie Kelly

Hi Harsh.

Harsh Hemnani

Hi. Hey Sumit, you mentioned that you're looking to grow the development side of the business, as far as looking at the initial use on those this quarter, they were roughly equal the yields on acquisition. I'm just trying to understand the spread over your cost of capital that you see on the acquisition side versus what you're aiming towards on the development side long term.

Sumit Roy

Yeah, Harsh, very good question. But again, it's a function of the mix, where the development dollars are going. If it is going towards industrial assets, which you will see that it is, the vast majority of the capital is going towards takeouts. And those cap rates, if they have a 5 in front of them, that's a great outcome. Because guess what happens once these assets are fully developed, and you go out into the open market, and you try to buy it from the open market, it potentially has a low 4s, even a 3 handled in front it. And that is the reason why we feel like yes, these cap rates, headline cap rates may look low. But if you really dive in behind the numbers, and you try to figure out what is the product that they're being able to get through this development funding, takeout funding, whatever you want to call it versus what could they buy the same particular asset, if it were available today, there is still 100 basis points, maybe 50 basis points, if you want to be conservative optimist, that we are getting by partnering with some of these very well-established global developers.

So that's really where the value creation is. To answer your question more specifically what do I see the yield on development.

If you look at retail, when you look at retail development, it depends on whether it's a repositioning or a Greenfield or what hasn't. On repositioning, that's where the maximum value creation occurs, we already have the piece of land, we go down the path of creating or repositioning an asset with the expectation that, you know, an AI through some of these numbers out at you that we could have ran compared to the privy positioning of 150, 200 even 300 - or 300 percentages of points.

So that's the kind of uplift in value we could generate through this.

Now that is a small portion of our business, a very small portion. But I just want to put in perspective that you see a blended number, but if you go behind the number there is a fair amount of value creation. And largely we want to be viewed as a one stop shop by our tenants who know us as landlords that hold assets for the long term. And if we can help them, harness our vacant asset portfolio by repositioning it for their needs. We want to be there to serve them. And that's the reason for having this. But in terms of how big is it going to become? What is the trend line going to look like? It's going to be a function of what dominates in that one given quarter.

Harsh Hemnani

That's interesting. And then one more for me, on the debt synergies from the very first deal.

Given that you have a lower cost of capital in the UK, could we expect to see a higher leverage ratio on your UK assets than in the U.S.?

Sumit Roy

No, again, it goes back to our ratings Harsh.

If you want a guiding principle, look at our balance sheet on a fully consolidated basis. And we want to be right down the fairway which keeps our rating agencies very happy. Yeah, that allows us the maximum flexibility to run our business. But we do not want to do anything that's going to compromise our A minus A 3 rating.

Now, the mix of where that comes from, could absolutely change. A lot more of it could come from the UK, given the ARB between a tenuous Sterling denominated unsecured bond versus a U.S. unsecured bond. And we may choose again just to match fund our assets with locally denominated capital, we may choose to over lever some of those assets. But there is a threshold beyond which we are not going to go, even on a standalone basis. But yes, we can certainly have more of a mix coming from the UK given the lower cost there than the U.S. And then if you look at it on a fully consolidated basis, it's going to have the same profile that you would expect of an A 3 A minus rated company. I hope that answers your question.

Harsh Hemnani

That's helpful. Thank you.

Christie Kelly

Thanks, Harsh.

Operator

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.

Sumit Roy

Well, thank you all for joining us today. And we look forward to speaking with each of you soon. Thank you so much. Bye-bye.

Operator

This concludes today's conference call. Thank you for participating.

You may now disconnect.