The Ground Up Ep 4 - Realty Income (O) CEO Interview

Very nice to see you again Brad. It's been a while.

Sure and thank you again for having me Brad. It's such a pleasure to be here with you. Look there's a fair amount of momentum in our business and I would say in the sector at large. A lot of companies have come out with very positive results and we were no different. We do see an acceleration in our business despite what we are seeing geopolitically, despite what we are seeing in the Middle East, despite the volatility with the 10-year to be very frank. You know, cap rates have remained stable and business is getting conducted and I think there are a lot of big picture trends that are taking place that we are leaning into and working from a position of strength. We increased our guidance on the investment side by half a billion dollars to $10 billion. Like you mentioned we increased our earnings guidance by two cents with four months left. If that's not a strength of conviction I don't know what is. And so if you look at even from an asset management perspective which we obviously pride ourselves in being very well-versed at, very conversant with, our releasing spreads were 102.7% which is a reflection of the portfolio at large and what we're being able to achieve when a lease comes due. I think these are all indications of a business that if you were to step back and look at geopolitically like wow there should be a lot of tension in the business it is the exact opposite. We feel very confident about the swim lanes that we've created. And I know Brad, we're going to touch on a little bit about what is different today about Realty Income versus what we looked like 20 years ago. And I'll tell you the thing that is not different. And that what's not different is the type of leases that we enter into and the platform that we've created and the ethos with which we conduct every element of our business which is our monthly dividend and every decision that we make, every strategy that we construct and then follow and implement is singularly focused on how do we make sure that we continue to preserve and grow this monthly dividend quarter in quarter out. Just like when we first listed we were 100% retail owned and today we're still 22-23% retail owned business. We want to make sure that that continues to guide every decision that we make. So very excited about where we are. As you mentioned we had our earnings yesterday. We shared a lot of what I just shared with you and your viewers and super excited about what's to come.

Yeah. So Brad, what makes us different is we are not developing data centers ourselves. We rely on the experts to do that. Digital Realty was our first JV and we are not getting into the core business of data centers as somebody who's been writing about data centers for the last 20 years would think about this business. We are not interested in colocations. We are not interested in cross-connects. What we are singularly focused on are the hyperscale long duration assets that are located in primary markets that we believe is going to be the next evolution that's going to contribute to these productivity gains that we saw in the late 90s and early 2000s with the technological changes that were coming through. And given the type of leases that one can enter into and I would put Cloud Capital the latest JV that we announced the $6 billion JV that we announced as one of the best-in-class. They started doing data center development in the late 90s. And you may recall Brad they actually were the business that they had as a public entity was DuPont Fabros and Cloud Capital basically is the same founder that founded DuPont Fabros. They sold that business to Digital Realty and then Cloud Capital was formed. We are very particular about the type of data centers that we're investing in. So it's not only location, you called it beachfront. I'd say primary locations. All of our investments so far has been in Northern Virginia, the epicenter of the data center world. But it is also the type of assets, it's largely AI-driven. It's this digital infrastructure that people are leaning into. Internet of Things, streaming, cloud computing, all of this is what's driving this massive demand. And the biggest of the demand drivers are obviously what's happening in AI and how that's sort of creating these productivity gains and is anticipated to create even more productivity gains going forward. The type of leases is very important to us. They need to be long duration. The actual credit needs to be the top three, top four hyperscalers that's very important to us. The landlord responsibility that we have in these buildings for the 15-20 year leases needs to be absolute bare minimum if any and the partner of choice the operator who we want to underwrite and partner with and provide our capital to needs to be best-in-class and I think if those boxes are checked then we feel comfortable moving forward and that's what Cloud Capital is. They control a lot of land in Northern Virginia and are one of the best developers of data centers and they have existing relationships with these hyperscalers that allows for the right type of leases to be constructed ones that we feel very very comfortable underwriting. So that was where we see the demand where we see the type of leases we feel like this is going to be accretive to our internal growth profile it's going to be accretive to our credit profile it's going to be accretive to our weighted average lease term these types of investments and so this is precisely the type of investments that we would like to make again going back to the central ethos of it'll feed our dividend it'll allow us to grow our dividend quarter in quarter out. So, they're all sort of tied together as to why this is of interest to us. And we can get into an intellectual debate around the residual risk and the fungibility and all of that. But when you're entering into 20-year leases, as you know, Brad, with minimal, if any, capex during those first 20 years, and you're in the right locations, you can feel pretty comfortable about the downside risk that you're assuming in these types of situations. So that's the storyline around why data centers. It's a great partnership. It's one that we will continue to grow and it started off as a credit investment. People were asking us three years ago, two years ago when we said look we're going to lend our capital to our partners to our clients because we believe that that might be the best way to get to the real estate. This is a clear example of that narrative where we started off lending on a development project which we were then able to take that capital and flip it into an equity investment into the real estate because they got to know us we got to know them and that led to now a long-term programmatic JV that we announced recently.

Yeah, great question. In fact, that question was asked yesterday during our earnings call. The good news is with Cloud their pipeline actually also exists in Europe. We're very comfortable investing in the FLAPs as you know those are the primary data center markets in Europe and I think through the right partnerships we are very comfortable owning data centers in Europe. So I just wanted to get that last question out of the way. But industrial has been something that we started investing in in 2010-2011 that time frame and the biggest driver of that was e-commerce. If you recall Brad going back to how we've evolved as a business we were 100% US retail business prior to then and then we saw what happened with Borders and we saw what happened with some of these book companies that were selling books in brick-and-mortar stores when Amazon came in we leaned in and we said you know what e-commerce is going to be a very big part of how retail is going to get delivered to the end consumer and we would like to participate there. And again, most of these retailers, Amazon being one of the main ones, they wanted to be a single tenant user of these distribution boxes and sorting centers, etc., etc. So, we started to lean into the industrial business starting in the early 2011-2012 time frame. And fast forward to today, it is now almost 17% of our business. 75% of what we did in the second quarter was industrial. And what we are now seeing is that it is much more broad-based than just e-commerce. Manufacturing is coming back on board. Onshoring is becoming very important. Nearshoring is becoming very important. There's a lot more defense spending and infrastructure spending that is taking place in Europe. And so we want to be located in the right geographies positioned appropriately to take advantage of these opportunities when they come and a lot of what we are playing Brad is through the build-to-suit side of the equation. So there again we are partnering with the right developers who have the right land locked up and with the right leases that we can then help finance and ultimately end up owning the real estate. And that's been the playbook and that's what allows us to continue to get these at yields that make sense for us. We are a spread investor at the end of the day and so that's what allowed us to do industrial both here in the US as well as in Europe largely driven by these macro factors that I just mentioned.

I think it's very important Brad. When you look at the asset side of our balance sheet, we created all these various different swim lanes. It continues to add to the diversification and it continues to add to exposure to industries that we wouldn't have had exposure to. I don't think there are tech companies that are using retail boxes, brick and mortar to sell their technology. And so it's just a diversification play. We got that down and we are continuing to evolve that. What we didn't have was on the right hand side of the balance sheet where you were thinking in terms of how do we finance our business? We created on the fixed income side obviously these various different geographical exposure allowed us to create a multitude of unsecured bonds that we could issue. But on the equity side we were beholden to just the public markets which by the way has served us immensely over the last 32 years of our public history. But it behooved us to take advantage of the platform that we had created to create these other channels of equity capital that would then allow us to create growth for our business by effectively leveraging our platform and charging a management fee on managing these third party capital and all they're looking for is a manager that can allow them a net lease strategy that they are buying into. It's a core plus strategy for the real estate. So this was a win-win situation and we were able to then pursue transactions and we did that last quarter where we did certain deals that we couldn't have done on balance sheet alone. These were lower yielding deals but with a lot more growth associated with it. $670 million plus deals were done in the open-ended perpetual life fund that we've built and they had a cap rate in that 6% zip code. And so clearly that's not something we could have done on balance sheet. But because we had this other pocket of capital, we were able to do that. And they tend to have higher growth if you look at the actual growth profile of the fund it's closer to 2.9%. Whereas our balance sheet is 1 and a half percent. So it's a win-win and we are able to then generate fees for the benefit of our public shareholders for which they're not having to pay. They're effectively leveraging the platform that we've created. So this ecosystem that we've created to create all these multiple channels of capital that we are basically executing the same model is super important to the success and the future evolution of large-scale companies like ours and Brad you're going to see this with other go down every sector you're going to see folks are if they're not already doing it they're thinking about doing it and not everybody will be able to do it. It'll have to be the best-in-class, the most scale, the biggest that will have the opportunity to do what we've been able to do on the private capital side.