Business context and reporting period
Realty Income Corporation (NYSE: O) filed this unaudited Form 10-Q for the quarter ended September 30, 2022. The REIT owns and leases commercial properties, primarily under long-term net leases. At quarter-end it owned 11,733 properties across the U.S., Puerto Rico, the U.K. and Spain, with 98.9% occupancy and an approximately 8.8-year weighted average remaining lease term.
Comparisons with 2021 are materially affected by the November 1, 2021 VEREIT merger: 2021 results exclude VEREIT, while 2022 results include it. The company also completed its Orion office-property divestiture in 2021.
Financial and operating results
| Metric | Q3 2022 | Q3 2021 | Change |
|---|---|---|---|
| Total revenue | $837.3 million | $489.9 million | +70.9% |
| Net income available to common stockholders | $219.6 million | $135.0 million | +62.7% |
| Diluted GAAP EPS | $0.36 | $0.34 | +5.9% |
| FFO per diluted share | $0.97 | $0.85 | +14.1% |
| Normalized FFO per diluted share | $0.97 | $0.89 | +9.0% |
| AFFO per diluted share | $0.98 | $0.91 | +7.7% |
Management attributed revenue growth primarily to VEREIT and acquisitions. Same-store rental revenue, excluding reimbursable amounts, increased 1.0% year over year in Q3; the company says this would have been 0.3% excluding rent deferrals and uncollected rent included in its calculation. Re-leased units achieved a 108.5% rent recapture rate during the quarter.
Reported net income includes gains on real estate sales and foreign-currency and derivative impacts; therefore, GAAP earnings comparisons may not reflect recurring property performance. Q3 real estate sale gains were $42.9 million, versus $12.1 million a year earlier. Foreign currency and derivative loss was $22.9 million, versus $2.4 million.
For the first nine months, revenue was $2.455 billion, net income available to common stockholders was $642.1 million, diluted EPS was $1.06, FFO per share was $2.99, Normalized FFO per share was $3.01, and AFFO per share was $2.92. Operating cash flow was $1.933 billion, compared with $970.1 million in 2021. Investing activities used $4.529 billion, chiefly for real estate investment; financing activities provided $2.634 billion. Cash, cash equivalents and restricted cash totaled $288.9 million at period-end, including restricted amounts; balance-sheet cash and equivalents alone were $187.7 million.
Cash distributions to common stockholders were $1.343 billion for the first nine months, equal to 76.0% of AFFO. The monthly dividend increased four times in 2022; the October-declared rate was $0.2480 per share, or $2.976 annualized.
Balance sheet, debt and liquidity
At September 30, 2022, total assets were $45.9 billion, total liabilities $19.0 billion and total equity $26.9 billion. Outstanding borrowings across notes and bonds, mortgages, term loan, revolving credit and commercial paper were approximately $16.14 billion. Management reported debt at approximately 30.6% of total market capitalization.
The company had $1.2 billion drawn on its $4.25 billion unsecured revolving facility and $3.05 billion of available capacity, subject to customary borrowing conditions. Commercial paper outstanding was $723.8 million and was due between October 2022 and January 2023. Cash and equivalents were $187.7 million. Management stated that cash, operating cash flow and borrowing capacity should meet liquidity needs for the next 12 months. It identified approximately $1.3 billion of obligations due through the remainder of 2022, expected to be funded through operating cash flow, equity or debt issuance, and credit-facility or commercial-paper borrowings.
Notes and bonds had $13.13 billion principal outstanding, a 3.3% weighted average interest rate and 7.3-year weighted average remaining maturity. Mortgages payable were $840.7 million; $740.5 million of mortgage principal was scheduled to mature in 2024. The company reported compliance with debt covenants. Its senior-note covenant metrics included debt to adjusted assets of 39.8% against a 60% limit, secured debt to adjusted assets of 2.2% against a 40% limit, debt-service coverage of 5.5x against a 1.5x minimum, and unencumbered assets equal to 259.0% of unsecured debt against a 150% minimum.
Variable-rate debt creates exposure to rising rates: management estimated that a 1% rate change on the $1.2 billion revolving-facility balance would change annual interest costs by $12 million. In October 2022, after quarter-end, the company issued $750 million of 5.625% senior notes due 2032.
Material changes, outlook, risks and unusual items
- Portfolio investment: The company invested $5.10 billion in acquisitions and development during the first nine months, including 639 acquired properties and 127 properties under development. The combined initial weighted average cash lease yield was 5.8%. It had $764.9 million committed under development contracts at quarter-end.
- Capital raising and debt: The company raised $2.4 billion net through common-stock offerings in the first nine months, including ATM and forward sales. About 20.0 million shares under forward sale confirmations remained unsettled at quarter-end; the company expected physical settlement in Q4 for approximately $1.3 billion of gross proceeds, subject to the agreements and settlement terms. The new $4.25 billion revolving facility replaced a $3.0 billion facility, and the company expanded its U.S. commercial-paper program and established a Euro-denominated program.
- Cineworld/theaters: Cineworld, parent of Regal Cinemas, entered Chapter 11 in September. Realty Income collected approximately 85% of contractual rent across its theater portfolio for Q3, then reported collecting all contractual rent for October. Quarter-end receivables from Cineworld and affiliates were $31.0 million net of reserves; cumulative reserves were $23.5 million. Regal represented 1.5% of portfolio annualized contractual rent.
- Potential transaction: Realty Income announced a $1.7 billion sale-leaseback agreement with Wynn Resorts for Encore Boston Harbor, with expected Q4 2022 closing, a 5.9% initial cash lease yield and a 30-year initial lease term. The company cautioned that closing conditions and timing were uncertain; the filing does not establish that the transaction subsequently closed.
- Foreign currency and inflation: Foreign-currency remeasurement and derivatives generated material period-to-period earnings volatility. The company uses foreign-currency borrowings and derivatives to manage exposure, but hedging cannot eliminate all risk. Lease escalators may not keep pace with inflation, and inflation can pressure clients when their costs rise faster than revenue.
- Other items and guidance: Merger and integration costs were $3.7 million in Q3 and $13.0 million year to date. Real estate impairment provisions were $1.7 million in Q3 and $16.4 million year to date. The filing provides no specific earnings or FFO guidance. Management said it expects to continue monthly dividends but did not guarantee the current level or future increases. The company reported disclosure controls were effective and no material change to previously disclosed risk factors.
Important facts for investors to verify
- Separate organic same-store growth from the effects of the VEREIT merger, acquisitions, divestitures, currency and rent deferrals; compare the company’s non-GAAP FFO and AFFO definitions with those of peers.
- Monitor Cineworld’s bankruptcy process, subsequent rent collections, reserves and any changes in theater-tenant credit risk.
- Confirm the status, closing conditions, financing and final lease economics of the Wynn transaction.
- Track the settlement of forward equity sales, resulting cash proceeds or share dilution, and the company’s continued access to equity and debt markets.
- Review near-term commercial-paper maturities, debt refinancing costs, interest-rate exposure, development commitments and compliance with debt covenants.
- Assess dividend coverage using operating cash flow and AFFO, while noting that AFFO is a non-GAAP measure and is not itself a measure of liquidity.