Good day, and welcome to the Realty Income second quarter 20 earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key.
After today's presentation, there will be an opportunity to ask questions. To withdraw your question, please press star, then 2. Please note today's event is being recorded.
I would now like to turn the conference over to Alexander John Waters, Vice President, Investor Relations. Please go ahead.
Thank you for joining Realty Income's second quarter 2026 results conference call. Joining us on the conference call today are Sumit Roy, President and Chief Executive Officer Jonathan Pong, Chief Financial Officer and Treasurer Neil Abraham, Chief Strategy Officer and President, Realty Income International and Mark E. Hagan, Chief Investment Officer. During this conference call, 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 our Form 10 Q filed with the SEC. We will observe a 1 question and 1 follow-up limit during the Q and A portion of the call.
To ensure that everyone has an opportunity to participate. And with that, I would now like to turn the call over to our CEO, Sumit Roy.
Sumit Roy
President & Chief Executive Officer
Thank you, Alexander, and welcome everyone. Realty Income delivered another strong quarter in Q2. Reflecting the benefits of our diversified investment strategy and our position as a trusted capital partner to many of the world's leading companies.
Our investment activity highlighted the breadth of our opportunity set demonstrating our ability to invest across the capital stack geographies and property types to support accretive growth. Against that backdrop, AFFO per share grew 3.8% to $1.09 during the quarter. Year to date, AFFO per share was $2.22 representing 5.2% growth and a meaningful acceleration from the same period in 2025.
This momentum supports $0.02 increase in our full year AFFO per share guidance midpoint to a new range of $4.44 to $4.45 representing growth of approximately 4% at the midpoint. We are also increasing 2026 investment volume guidance from $9.5 billion to $10 billion as our pipeline remains robust. I will cover key investment highlights during the quarter before detailing market dynamics in each of Realty Income's strategic areas.
Global investments totaled approximately $2.6 billion or $2.1 billion at our pro rata share. At an initial weighted average cash yield, of 7.3%. Second quarter activity was weighted more heavily toward The United States with approximately $1.7 billion in pro rata investments at a weighted average cash yield of 7.4%.
Including roughly $800 million in industrial assets, representing approximately 75% of U.S. real estate investments. Also embedded within this U. S. Activity was continued deployment through our U. S. Core Plus fund, which acquired approximately $73 million of assets on a global basis with industrial representing more than half of that volume and retail accounting for the balance. In Europe, we closed on approximately $400 million at a weighted average yield of 7%.
Finally, on June 30, we announced a $6 billion programmatic hyperscale data center joint venture with Cloud Capital in which Realty Income expects to invest up to $1.4 billion over time for its 45% equity interest. Turning to additional investment details, let's start with Industrial, which represented approximately 65% of our global real estate investments. We continue to find attractive risk adjusted opportunities supported by improving fundamentals and contractual rent escalators that generally range from 2%-3.5% annually.
Just under half of Industrial acquisitions NOI this quarter, came from investment grade clients with investments concentrated in high quality primary and infill markets. Notably, U.S. Industrial fundamentals strengthened during the quarter as net absorption accelerated sharply. Vacancy declined and development activity began to improve alongside market conditions.
That positive industrial momentum also carried through to our U. S. Core Plus fund, which continues to demonstrate the value of pairing our scale and sourcing with long term private capital. During the quarter, we fully deployed the Fund's remaining cornerstone commitments increased total gross asset value to approximately $3 billion. Assets acquired into the fund in Q2 generated a 6% weighted average cash yield.
While these investments carry lower initial yields, they consist of high quality assets in attractive markets leased to strong credit customers and supported by contractual rent escalators well above average. A dynamic reflected in the Fund's 2.9% year to date same store revenue growth. Importantly, the management fee stream from the fund enables us to pursue these lower initial yield investments with day 1 accretion to Realty Income's shareholders.
Thus expanding our overall buy box. In Europe, while several international clients were more cautious earlier in the year amid geopolitical uncertainty, activity has improved and a number of those clients are actively pursuing transactions today. Europe continues to offer attractive risk adjusted investment spreads, supported by lower borrowing costs.
Our established presence in the region and a landscape that remains less competitive than in The US. We remain constructive on Europe and continue to view it as an important contributor to our growth over time. Turning to data centers, our joint venture with Cloud Capital establishes another large scale programmatic investment vehicle.
The venture includes 3 Northern Virginia data center assets representing under 400 megawatts of capacity. We closed on the first stabilized asset last week, and expect to acquire our share of 2 development assets upon stabilization. Our partnership with Cloud Capital originated from a prior credit investment and has evolved into a long term relationship focused on developing and owning hyperscale data centers across leading U. S. And European markets.
Since announcing the venture, data center dialogue has continued to increase expanding our access to opportunities across the sector. We believe the industry is still in the early stages of a multiyear digital infrastructure build out driven by AI adoption cloud computing and broader digitization trends. As a result, demand for data center capacity continues to exceed available supply in many of the industry's most attractive markets.
We remain focused on top tier supply constrained markets and partnering with experienced operators that value our long term programmatic financing capabilities. Across our investment activity, our scale and sourcing platform continue to be significant advantages that are difficult to replicate through individual asset acquisitions. As an example, earlier this year, the fund acquired a combined 19 property portfolio leased to a top performing quick service restaurant operator for more than $100 million.
A subsequent third party valuation completed in connection with our core Plus fund verified a prevailing market cap rate for the portfolio that is more than 30 basis points below our acquisition basis. Providing tangible evidence of the immediate value creation that can be achieved through portfolio transactions. While acquisitions and capital deployment are important drivers of long term growth, we are seeing increasing opportunities to create value through active portfolio management and capital recycling.
During the quarter, we completed $161 million of dispositions reallocating capital towards areas of the portfolio where we see the strongest combination of organic growth pricing power and value creation. Importantly, this approach is not limited to non core or vacant assets, but extends across the portfolio whenever we believe capital can be redeployed more strategically. This disciplined approach enhances portfolio quality, improves capital efficiency and supports sustainable earnings growth.
Looking ahead, we continue to see attractive opportunities to recycle capital into assets that are better aligned with our long term strategic priorities. We also continued to improve portfolio quality during the quarter with investment grade client exposure increasing to 34% of annualized rent from 32% in the first quarter. Portfolio fundamentals remain strong, occupancy of 98.8% and 482 re leased units generating a blended rent recapture rate of 102.7%, with renewals at 104.6%.
This included a large batch renewal with a single client covering nearly 150 assets, demonstrating the scale and efficiency of our platform. Industrial comprised approximately 1 third of leasing activity during the quarter and generated a rent recapture rate of 105.8%, while international recapture rates reached 112.9%,. Reflecting the continued success of our UK value add retail park strategy.
Our international retail park strategy continues to benefit from limited new supply strong retailer demand and record low vacancy rates helping drive attractive leasing spreads and incremental value creation. Importantly, the growth and diversification of our investment capabilities have been matched by similar progress on the capital side of the business. Our expanding capital platform is reducing our reliance on public equity while enhancing our ability to fund growth efficiently.
With that, I will turn the call over to Jonathan.
Thanks, Sumit, and good afternoon, everyone. The second quarter demonstrated our commitment to diversifying our sources of capital on a global scale while maintaining a healthy balance sheet. We continue to operate from a position of significant liquidity conservative leverage and broad access to multiple capital channels.
We ended the quarter with approximately $3.5 billion of available liquidity, on a pro rata basis. Net debt to annualized pro forma adjusted EBITDA at the end of the second quarter stood at 5.4x or 5.2x inclusive of unsettled ATM forwards. Which is well within our target range.
Subsequent to quarter end, we further enhanced our liquidity profile through an expansion of both our global revolving credit facility and commercial paper program. An unsecured bond offering in Europe and continued forward equity issuance under the ATM. Our updated credit facility now provides for borrowings of up to $5.5 billion, an increase of $1.5 billion from the prior facility with a 5 basis point reduction to our borrowing rate.
Similarly, we expanded our global commercial paper program to $5.5 billion, an increase of $2.5 billion. Secondly, we completed a €600 million-denominated bond offering at a yield of 3.7%. And finally, we raised an additional $90 million of forward equity, bringing our current ATM unsettled balance to approximately $1.3 billion.
Pro forma for these transactions, available liquidity increased to more than $5.7 billion. With our enterprise value approaching $90 billion and a robust pipeline of external growth opportunities, the access to additional capital enhances our ability to immediately finance our investment pipeline while remain patient and opportunistic in accessing longer term and permanent capital. As a reminder, outstanding borrowings on our credit facilities and commercial paper programs represent our only exposure to variable rate debt.
And we intend to maintain the variable rate exposure at 10% or less of our total outstanding debt. Our commitment to maintaining a strong balance sheet supported by access to multiple sources of capital, was recently recognized in Fitch's initiation of coverage for Realty Income with a solid A long term issuer default rating. This rating places us among just 4 US REITs with a solid A or equivalent rating from 1 of the 3 major rating agencies, and we are grateful that our size diversification, and track record of performance have elevated us to this rating.
We remain active on the capital raising front inclusive of the aforementioned euro bond offering, we have issued $3 billion of new debt year to date at a blended effective coupon of 3.9% compared to $1.4 billion of debt that has matured to date at a blended coupon of 4%. We continue to diversify our sources of debt capital across different currencies, and investor capital pools with the focus on avoiding saturation or reliance on any 1 market while lowering our all in cost of borrowing and managing appropriate maturity ladder going forward. On a year to date basis, we have issued 4 discrete debt instruments, including a convertible bond a U. S. Dollar unsecured bond swapped to euros, a municipal prepaid term loan swap to euros, and a euro unsecured bond.
Each of these debt instruments was selected with an intentional bias towards tapping into a unique investor base as well minimizing our global and blended cost of debt. On the equity side, private capital has reduced our reliance on public equity markets to fund our growth. As a result, we have meaningfully lowered our public equity consumption as a percentage of investment volume comprising only 18% of investment volume year to date compared to an average of 47% over the past 3 years.
Year to date, we have settled only $825 million of forward equity to close on $4.7 billion of pro rata investment activity all while maintaining leverage within our 5.5x target level. This reflects the benefit of our recent capital initiatives, which have diversified our sources of equity capital. Turning to our 2026 outlook, as Sumit mentioned, we are increasing our full year AFFO per share guidance range to $4.44 to $4.45, also increasing our full year acquisitions guidance to $10 billion, up from $9.5 billion previously.
This reflects the strength of our investment pipeline and the confidence in our ability to source and execute attractive opportunities. At our share, we expect to invest approximately $9 billion during 2026. We are also holding our 2026 credit loss outlook flat at around 40 basis points of rental revenue reflecting stable operating performance across our client base.
Notably, we are not raising our lease termination income guidance We recorded approximately $1 million in the second quarter and continue to expect $45 million to $50 million for the full year. As a result, the increase in AFFO guidance reflects the underlying strength of the business in terms of investment volumes yields modest credit losses, the successful execution of several capital markets transactions, and our expectations for continued momentum throughout the balance of 2026. With that, I will turn the call back over to Sumit.
Sumit Roy
President & Chief Executive Officer
Thank you, Jonathan. In summary, the second quarter represented disciplined execution across the platform. Highlighted by continued performance of our high quality portfolio disciplined capital allocation at attractive yields, and the curation of unique capital vehicles that provide Realty Income with durable financing engine to accelerate AFFO per share growth in the years ahead.
With that, I would now like to open it up for questions. Rocco?
Thank you. We will now begin the question and answer session. Ask a question, you may press star then 1 on your telephone keypad.
If your question has already been addressed and you would like to remove yourself from queue. Once again, that is star then 1 if you have a question. And today's first question comes from Michael Goldsmith at UBS.
Please go ahead.
Good afternoon. Thanks a lot for taking my question. The acquisition cap rates during the quarter were 7.4%, which is a bit lower than you saw last quarter.
Is that a reflection of mix competition or something else that had to play into, also the industrial assets with the elevated lease escalators? And just how should we think about the accretion on cap rates of 7.4%?
Sumit Roy
President & Chief Executive Officer
Yes, that is a great question. The idea here is to always try to blend to a number that is getting us back to our historical spreads Michael. And the blended cap rate or the investment yield is 7.4%.
And When you think about the portion north of $100 million was in the fund, that was where the lower yielding cap rates went and that was by design because that is why the fund was created. Stuff that we could not accretively buy on balance sheet was going to be allocated to the fund. Where the long term return hurdles were going to be met, but that initial accretion was not.
And so what is remaining is has a profile that gets us to our historical spreads of circa 150 basis points. that is how you should think about our investments.
Thanks for that clarification. And then just as a follow-up, can you provide an update of where we are in terms of generating fee income as the amount in the quarter? Is that kind of the right run rate?
Or do you expect that to accelerate from here? And then also, how much is included in the underlying guide?
Hey, Michael. So if you look at the supplement, I believe at Page 22, we do show management fee income to realty income. It was about $3.2 million for the quarter.
The majority of that obviously is for The U. S. Core plus fund. We had raised $1.7 billion during our cornerstone round And, you know, as of early July, we had drawn down all of the capital that is now fee generating. There is also, you know, a separate component of that is attributed to the insurance JV that we announced back in March.
And so in totality, that is where you get the 3.2. In terms of guidance, we have talked about this before, but we expect around $10 million or so for the fund in terms of management fees. And then, then, you know, perhaps there will be $2 million to $3 million, attributable to insurance JV.
Our next question today comes from Brad Heffern at RBC Capital Markets. Please go ahead.
Hey, afternoon, everybody. Thanks for the questions. Obviously, rates have been bouncing around a lot, but generally going up.
But we have also been hearing some of your peers talk about some slight cap rate compression I guess, first, are you seeing that as well? And then do you think higher rates will eventually flow through or, are competitive dynamics preventing that from happening?
Sumit Roy
President & Chief Executive Officer
that is a great question, Brad. it is a very strange environment really because this inverse correlation that exists between how net lease generally trades versus the 10 year. Largely holds true. But what has happened over the last 2 months is that inverse correlation has not held true.
It really is a question of what is going to happen to the tenure? What is the forward outlook? Not so much where it is trading at today, that is going to dictate what is going to happen to cap rates?
We have oftentimes talked about cap rates being a trailing variable when it comes to interest rate the 10 year treasury. And If the view is that the 10 year is going to be in this 4.6% to potentially 5% ZIP code, then what we have historically seen is cap rates do follow. But you mentioned it in your question, the way you framed it, there is a lot more competition here in The US.
There are a lot more new entrants on the private side along with a few on the public side. And so there is that competitive dynamic that is going to keep cap rates lower. But ultimately, in a highly elevated cost of capital environment, cap rates will need to adjust.
Okay. Got it. Thank you for that.
And then you talked a bit about the positive European outlook in the prepared comments. I wanted to specifically zoom in on The UK Cost of debt seems pretty unattractive over there, especially compared to euro debt. So are you seeing upward pressure on cap rates in The UK to reflect that?
Or is it just a less appealing market right now?
Thanks, Sumit. Brad, in response to that question, I think we have countervailing effects. 1, of course, is the sort of macro malaise change in the PM the move in rates. Against that, what you have is institutional capital coming in and you see this more broadly across Europe as well.
And it started really with malls or shopping centers as they are called over there. And there is quite an aggressive bid for those kinds of assets. So in The UK, almost perversely, we are actually seeing institutional capital coming in good size, driving down cap rates.
And then while we have not bought retail parks or multi tenant retail across the continent, There is also now 1 or 2 larger private equity players driving consolidation. I think the industrial logic is that they sort of missed that play in The UK, but there is still an opportunity across Europe. And the low level of base rates makes it actually quite accretive on a levered basis.
And so I do not think we are seeing upward pressure on cap rates in The UK or frankly much of Europe with the exception of Germany. And I think, if anything, the pressure on cap rates downward on retail parks in The UK will continue?
Our next question today comes from Rob Stevenson at Huntington's. Please go ahead.
Good afternoon, guys. Sumit, how should we be thinking about how much of the $5 billion or so of second half investments in the guidance is likely to be put on realty income's balance sheet and financed by the REIT versus going into various JVs, funds, partnerships, and anything new that you would create over, you know, the remainder of the year?
Sumit Roy
President & Chief Executive Officer
Yeah. So that 500. So we have said we are going to do about $10 billion. that is the guidance.
And what we have shared with the market is $9 billion of that $10 billion is going to be on balance sheet. And if you see what we have invested year to date, on the fund, we have largely used up the equity, the cornerstone equity, actually. We have completely used up all of the equity that we have raised.
And so the only assets that are going to go on the fund will be the leverage capacity that the fund has that is still available to it. And that is going to be obviously you know, it is the same ratio, 1/3, 2/3. So we have got about $1.7 billion that we have raised in equity.
We have got about 1/3 of that amount in leverage capacity deployed. But the rest of it will be on balance sheet. Okay. that is helpful.
And then with these various funds, JVs, partnerships, etcetera, that you now have in place, Do you have all of the sources of capital that you guys think that you need to execute the business plan? Over the next couple of years? Or should we expect to see more of these types of partnerships and JVs being announced over the next 6 to 12 months given what your pipeline looks like?
So Rob, I think in terms of the product that we are going to pursue from an investment perspective, that is largely defined. We have been talking about our desire to go into data centers We have now formed joint ventures. Is it possible that there could continue to be other JVs that we have form with developers who have a very healthy pipeline that fits our box?
The answer is yes. And especially on the heels of the conversation, on the heels of the announcement that we have made. There are some very interesting conversations that are taking place.
And that is much more in line with what we have already shared. The other asset types are ones that we are just continuing to invest in. And, obviously, the fact that we have created these multiple channels of geography and asset types, we are going where the best risk adjusted returns are.
On the financing side is where we are sort of still new in the game, and the rationale behind why we did what we did was to try to sort of leverage the platform that we have with a lot lower cost of capital, a lot lower cost of equity capital, let me be more precise. That we could then generate earnings contribution through the fee stream. I would say that we have-- that is the journey that we are on.
And it is-- I have heard Jonathan mention it as an ecosystem that we are trying to create where we are maximizing the utilization of a platform with you know, trying to attract the lowest cost of equity capital that wants to leverage and wants to pay fees and basically be exposed to net lease investing. So, you know, I will not go so far as to say what we have shared with you is the end all and be all of all equity capital sources. I would characterize it as it is the beginning.
And there will be other channels. What we are going to be acutely focused on is to make sure that the overlap on these various different sources of equity capital, private sources of equity capital, is very minimum. We wanna make sure that we are using our platform very judiciously to serve these various different sources of capital, make each 1 of them very successful, that this fee stream that we are able to generate continues to be 1 that is a very high level of permanence and 1 that we can count on and our shareholders can benefit from in years to come.
And our next question today comes from Smedes Rose at Citi. Please go ahead.
Hi, thank you. I just wanted to follow-up on kind of your acquisitions outlook. It looks like for your portion, the back half of the year is estimated around $4.3 billion.
So that suggests it decelerates a little bit from what you saw in the first half. Could you maybe just speak to kind of what you are seeing there? Is it slowdown by design?
Are you being conservative? Competition heating up? And just interested in any kind of color around that outlook.
Yes. Thanks for the question. Well, I think that with the guidance at $10 billion and the first half total investments of $5.3 billion.
I do not think there is a lot of deceleration in there, but Well, I am just looking at your portion. You said for your portion, it would be $9 billion for the year. Yes.
The overall global investment amount. But look, it is not driven by anything in terms of that we are seeing in the conditions in terms of deceleration. In fact, it is really the opposite.
We increased our overall volume guidance because of the strength and robustness of the pipeline. So, you know, as we are sitting here today, we really we feel great about the pipeline and about at least another strong second half of the year.
Sumit Roy
President & Chief Executive Officer
Yes. Okay and then you yeah. Go ahead.
Sorry. To you know, forecasting out and trying to back into, you know, what is the delta between what we have forecasted versus what we have not.
What I can tell you from a pipeline perspective, from the health of the pipeline, from what we are seeing, we feel great. Okay. And I just on that, you know, you obviously leaned into industrial in the quarter. just wondering, is that the primary focus going forward from here?
Or are you happy with the kind of exposure that you have in that asset class at this point?
Sumit Roy
President & Chief Executive Officer
Industrial has always been a focus of ours. We obviously cannot go into the 3-cap deals that we just saw recently announced. Industrial single tenant industrial more specifically across various geographies has always been something that we have leaned into.
And the way we are playing that is through the development channel. Is partnering with the best in class developers and being able to generate yields with more of a built to suit characteristic rather than a spec characteristic where we are able to meet the hurdles that we need to meet in order to generate the spread investing that you and our shareholders are used to seeing. So What you are seeing today is and I am sure you have heard it from other industrial companies, is this what we expect to be a new trend where absorption rates are trending very positive, vacancies are all at all time lows, And what is driving this demand is much more widespread than e commerce, which was the driver of industrial demand 4, 5 years ago. it is much more broad based. it is industrial, it is manufacturing, it is data center equipment that needs to be stored in warehouses, etcetera, that is that is also driving some of the demand.
We feel very good about the pipeline that we have created. We are being able to do it at cap rates and investment yields that make sense to us through a combination of investing on the credit side as well as on the equity side. Thank you.
And our next question today comes from Haendel St. Juste with Mizuho. Please go ahead.
Hey guys, thanks for taking the question. Sumit, maybe starting with you, I guess I was intrigued by some of the comments you are making about capitalizing on the market to do some portfolio recycling, improving the quality of your on balance sheet assets. So I am curious how much of the portfolio ballpark might be subject to being upgraded or recycled?
Sounds like you are doing a bit more IG here. Is that something we should expect near term and maybe some color or perspective on the difference in cap rates or bumps and what you are buying versus selling? Thanks.
Sumit Roy
President & Chief Executive Officer
that is a great question, Haendel. I think in the prepared remarks you picked up on our desire to continue to recycle capital Obviously, have talked about there are certain metrics that we are very focused on internal growth being 1 of them, duration of the lease term being another, being exposed to credit that we have a long term view on and we feel comfortable with is another metric that we are going to be very focused on. This capital recycling that we would like to continue to lean into is largely on a pro forma basis going to help make each 1 of these variables that I just mentioned accretive. that is the desire.
It could be obviously leaning into the data center side, leaning into the industrial side, and repositioning our overall portfolio to make sure that our net lease metrics that we focus on, KPIs that we are very focused on, continues to move in the right direction through this capital recycling.
that is great color. Thank you for that.
Jonathan, a question for you. Maybe if you will allow me a 2-parter. Just want to get some clarification on what is in the other adjustments per share It looks like we excluded that. the FFO, the AFFO per share guidance would be down.
Maybe I am misinterpreting it, so maybe some color on that And then just some color or thoughts on the duration of the loan book. Seems like there is a decent amount high yielding paper maturing the next couple of years. Curious if you guys are expecting to be able to originate more or you plan on managing that dilution.
Thanks. Hey, Haendel. So the other category is really nothing new. it is primarily FX related.
Gains or losses that are noncash in nature. You also have other CECL related type of impacts as well. But you know, that is nothing that would you know, raise, to the level of a cash adjustment that would impact the FFO and should not impact the AFFO given that it is noncash and it is nonrecurring.
I would say on the loan tenor, assuming you are talking about the investments that we make Look, we have talked about this before. But when you think about the right hand side, of our balance sheet, when you think about you know, a legacy balance sheet with a fair amount of debt that is rolling every single year, You know, this provides a nice hedge, if you will, a natural hedge where, you know, if rates go down, yes, theoretically, there is reinvestment risk, but also, you know, the other side of our ledger is also much more attractive in refinancing at much lower rates and vice versa. So we manage it.
We look at it just as closely as we look at you know, the liability side of the balance sheet. And that is how we risk mitigate and forecast what our exposure is. Should there be various scenarios that play out in the rate environment.
Thank you.
Our next question today comes from Omotayo Akyusanya with Deutsche Bank. Please go ahead.
Yes. Good afternoon, everyone. Just along Haendel's line of questioning in terms of capital recycling.
Could we see that also manifest itself as kind of new JVs or doing more with your current JV partners? Or how do we kind of think? Or is it are you going to take a much more just kind of outright asset sales?
Sumit Roy
President & Chief Executive Officer
Yeah. The idea being recycling. So, yes, we are continuously looking at our portfolio Omotayo, and we are trying to figure out where are the assets that are mispriced in the market where we do not have a long term hold strategic outlook on certain portions of our portfolio.
And we would much rather sell those assets, raise that capital, and redeploy it in either asset types or geographies or risk adjusted opportunities where we feel we have a much higher conviction on holding long term. What we are talking about. it is not supposed to represent additional JVs, etcetera. That is not the idea behind the capital recycling that you should sort of think about when we are talking about capital recycling?
Thanks for the clarification.
And our next question today comes from Alexander Fagan with Baird. Please go ahead.
Hey, thanks for taking my question. On the data center hyperscale deals, can you speak if after these 3 assets, are you diversifying your tenant base or the end tenant base? For your data center portfolio?
Sure. Thanks for the question. Yes, we are.
Obviously, we announced a transaction 3 years ago with 2 data centers in Northern Virginia. That had a specific tenant in it. The transaction that we just announced last month, that 3 data centers has varied tenants in it that are different than the original 2.
So we currently have the 5 assets with different tenants in them. And going forward, as we continue to build out our data center portfolio, that is 1 thing that we are going to keep our mind on as part of our strategy in terms of obviously, we want to focus on the investment grade rated hyperscalers and enterprise users. Those work well for us.
But we are going to be very mindful of making sure that we balance our concentration to any particular assets.
And kind of on the tenant question broadly, should we expect any new top 20 tenants entering the portfolio this year?
Sumit Roy
President & Chief Executive Officer
Well, Alec, when that happens, it will be announced and I think it will be viewed very positively. Obviously, these data center clients tend to be very large And you know, when those close, could it potentially reshuffle our top 20? The answer is yes.
But it will be viewed very positively, in my opinion. Thank you.
Our next question today comes from Ronald Kamdem with Morgan Stanley. Please go ahead.
Just staying on the data center portfolio theme, maybe can you talk a little bit more about sort of the economics whether it is sort of stabilized yields or price per megawatt just your views on that going forward. And also on the competition. Right?
Because I think there is a lot of big private equity players out there. there is other public capital. Just what that environment is like to get these deals through? Thanks.
Sure. Thanks, Ron. Let me hit the second part of the question first, if that is okay.
Yes, there are a lot of people in the sector right now both on the development side and people wanting to invest capital into this sector. So there is you know, a lot of competition for, both developing these assets and owning them. I think that 1 of the important things though is that there are a lot that are still in the development phase.
If we are talking about the large hyperscale data centers. And there is probably a lack of a natural home for the ultimate long term ownership of those assets. Some of the developers may want to keep ownership of them for the long term, but others do not.
And so that does create a despite the competition, out there and the players in the sector going after some of these assets. For somebody like us, whose model focuses on, you know, holding long leased assets, that have clients with strong IG credit ratings and with good annual bumps, there is a natural sweet spot for us, to be long term holders of that. And so I think that makes us perhaps a little bit different than, you know, some of the other people who are playing in the space right now.
In terms of your question on cap rates, I think there is still a bit of just overall discovery going on in the market. There are, a lot of these large assets are still rolling from the development phase into the potentially changing hands for the stabilized phase. And I think there is been some transactions that have been in the market recently that have been announced where there is some cap rate data out there on them.
I think that is a good indication of where cap rates are right now. these types of assets.
And then my second 1, if I may, I think just going back, I think the comments were 40 basis points in terms of chosen bad debt for this year. Just can you remind us, the watch list, sort of any changes over the last 3 months, any sort of larger tenants, or does it remain pretty granular?
Ron, the watch list remains in the high 5% area. And, you know, so it is a very granular watch list. I think there is 137 individual tenants that comprise that with a median about 2 basis points.
So at the very top, it is the usual suspects. I would say it is, home furnishings. it is casual dining, and then drops off pretty significantly thereafter. So when you were thinking about any changes to credit quality in the portfolio, very stable, Some things have come out.
Some things have gone in. But broadly speaking, from a guidance perspective or from a forecast perspective, 40 basis points does still feel fairly conservative. And I will remind folks that our historical credit loss, you know, across our entire history has been in the low 20-basis-point area.
So, we are trending back towards that area, but, you know, we still create a little bit of buffering cushion there. guidance wise.
And our next question today comes from James Kammert at Evercore. Please go ahead.
Again, if I get back to the data centers, there is no doubt there is abundant opportunity out there for realty income. I am just curious if I play devil's advocate If you are underwriting these to zero residual value given your bumps and you are going in representative cap rates, what would this zero residual value IRRs look like today?
Sumit Roy
President & Chief Executive Officer
James, we are not going to go into the details, but that is definitely 1 of the, you know, scenarios that 1 should look at. there is been a lot of debate about residual values, fungibility of these assets. Which is why the box that we have created takes into account you know, where these data centers are located, what is the throughput required, Do we see Northern Virginia suddenly in 20 years' time when the leases come due, will it no longer be the epicenter of data center world? Or do we see data centers demands completely dry up?
And so based on that, you run various different scenarios. And that is 1 of the reasons why we sort of lean into these very long duration leases. 15 to 20 years and preferably 20. And we are trying to partner with developers who have the ability such as cloud, to get these types of long duration contracts with very minimal you know, responsibilities on the landlord side.
And so what we feel is we run these various different scenarios, we are very comfortable with the downside. You know, we are very comfortable assuming you know, the outcome if the world were to completely fall apart and it is in fact going to be sold for land at the end. That is certainly a scenario we run.
But way we try to mitigate it is by looking at all of these other factors. You know. What is the what kind of an asset is it? what is the duration of the lease? what is the growth you are getting in it? what is your going in yield?
Those are the things that you sort of protect, you know, will allow you protection when you are running these downside and Herculean scenarios. So that is that is how I would leave it.
that is fair. And then quickly, what was your what were your tolerance in terms of absolute exposure to data centers as a percent of ABR or of your gross investment?
Sumit Roy
President & Chief Executive Officer
Yes. Jim, we are not targeting a percentage of our portfolio, needs to be data centers. What we are seeing is a once in a generation demand for a particular asset type that has clients that we are very attracted to in locations that we find very interesting.
And, you know, we are having multiple conversations. How many of those conversations actually translate to the transactions time will tell. But this is a fascinating environment for us and we are very excited about the deals that we do get over the finish line, the deals that we pursue and are able to sort of enter into.
We are going to talk about it, and we will be able to defend those every day. But we are as focused on some of the obsolescence risk and the residual risk that people talk about. And there are obviously mitigants we have built into the process to make sure that we only engage in transactions that have a return profile that meets our overall long term return expectations.
Thank you for the color, Sumit.
Thank you.
Thank you.
And our next question comes from Jason Wayne of Barclays. Please go ahead.
Thanks for the question. To step away from the data centers, so on the rest of the investment pipeline, you said you were still interested in Europe. Just wondering if you could give kind of a mix of what is in the pipeline today?
Sure. Neil will take that. Sure.
So look, I would say the mix today is largely reflective of the kinds of things we have done in the past and continue to like. So we are looking at deals in grocery, in DIY, on the industrial logistics space, And generally, many of these are with marquee names in their country or globally. Some of the industrial deals that Sumit alluded to are development driven.
The majority of what we are looking at today, I would say, is in markets where there is also a theme that we are looking to play, whether it is onshoring or advanced manufacturing. And I think the pipeline looks quite good across Europe as we look at the back half of the year.
Got it. And then you mentioned that public equity funding is was down to 18% of your investment volume this year. Is there any kind of long term target there since the private capital is obviously more 1 time in nature?
Look, Jason, I think it is going to depend on circumstances. And know, we are we are not saying we are never gonna touch the public equity markets. it is been very good to us over the years, and it is a very deep market. But we do not want to be beholden to just 1 source.
So whether it is 18%, whether it is 50, a lot of it is gonna be dependent on what other partnerships and how we grow our existing partnerships and source the private capital And then, obviously, the bigger question is, you know, the volume of opportunities that we see is very robust. So it is it is hard to put a number there. What we do want to make clear is that all of these sources of private capital are meant to, as Sumit mentioned, not overlap with 1 another.
Also increase the buy box. For us. And so there are deals that are very high quality, and I think you see that with the core plus fund.
In terms of what we are putting into the fund that you know, we have not been buying on balance sheet because of the lower initial yield. So I think from that standpoint, reason we went into this a matter of a few years ago was really to solve that 1 underlying question as to whether or not we could expand you know, our sources of equity beyond the public markets, and maintain a level of scarcity value in our securities, and, you know, not have as much exposure to a very volatile source of funding.
Sumit Roy
President & Chief Executive Officer
Yes. And Jason, just to be very clear, you mentioned that it is onetime in nature. it is the exact opposite of what we have created. I mean, the open ended fund by its by definition, will be a vehicle that will continue to raise capital out into the future. that is the reason why we constructed it as an open ended vehicle rather than a closed end fund.
The JV that we have with the GIC is meant to be a programmatic JV. Once we have utilized the initial capital commitment, the hope is that they will continue to deploy more and more capital with us. it is a similar situation with Apollo. So it is we are shying away from partnerships that etcetera, which is 1 time in nature or closed ended in nature.
Primarily because we want this, you know, fee stream to be permanent and growing into the future. So I just wanted to make that 1 correction, Jason. Thank you.
And our next question today comes from Jana Galan with Bank of America. Please go ahead.
Thank you. Good afternoon and congrats on the quarter. Jonathan, I just wanted to follow-up on the guidance increase to better understand the driver of the $0.02 increase at the midpoint.
Guess there is no change to bad debt, no change to fees. Is it just primarily the higher investment volumes?
A lot of what drives AFFO in a very finite span of time is timing. And then, obviously, you know, what we have not discussed is capital markets because for obvious reasons, we do not give capital markets guidance. And so I think, you know, between those 2, dynamics, especially since we are sitting here in August right now and a lot of the capital market execution risk has been taken off the table.
And given the fact that we have much better visibility today on a deal pipeline and, importantly, the timing of when those deals will close. Gave us a lot more comfort to take this guidance range up. So think it is really a combination of just derisking with certain question marks, that you inherently have at the beginning of the year and then, obviously, a very attractive know, pipeline of deals with more certain closing dates.
Thank you very much. Thank you.
And our next question today comes from Anthony Paolone at JPMorgan. Please go ahead.
Yes, thanks. Good evening. Have a question about just the allocation of capital in your investments across these various buckets?
I was wondering what a wholly owned acquisition yield needs to look like for it to be interesting? And the reason I ask is when I look at what you are doing, it seems like 8s and 9s on some of the loan investments in the 7s on the development and the fee enhancements from your various private capital sources will get you into the sevens as well. So when you get to a wholly owned deal, you know, what does that have to look like to kind of be interesting and competitive Yes.
Sumit Roy
President & Chief Executive Officer
The answer is it is different by geography. Anthony. that is the reality, and that is something that we are tracking on a weekly basis We have hurdle rates that need to be met. Because we need to permanently finance it.
And you know, what we try to generate is a 150 basis points of spread. that is what we have historically achieved And given dynamics that might be unique to certain geographies, you know, the cap rates need to get to those levels. Is going to differ. Obviously, you know, the cost of capital also comes into play, especially in places like Europe where they just tend to be a lot lower.
Given the cost of debt. But the corollary is also true. You know?
In places like The UK, I think there was a previous question that was asked, the cost of debt is slightly higher, and therefore, expectation is that deals need to have a higher yield to satisfy that 150 basis points of spread. So there is not 1 cap rate and it is definitely something that we track very, very closely and the team tracks very closely.
Okay. And I just have 1 just item to I am curious about. Your fee earning AUM, I think, went up $1.3 billion from Q1 to 2Q.
But when I look at like what your investment activity was, it was a $500 million difference between everything you did versus your share. Am I confusing a concept, or I would have thought that AUM would go up with that difference?
Sumit Roy
President & Chief Executive Officer
Anthony, I think you should think about the Apollo JV. Right? That was a contribution of assets off of a balance sheet.
And we are getting fees off of, you know, the portion that we are managing on behalf of our partner there. Thank you.
Our next question today comes from Greg McGinniss at Scotiabank. Please go ahead.
Hey. Good afternoon. Not to the belabor the point here, but back to data centers for a moment.
Are you open to data center investment in Europe? Curious how returns there compared to The US. And then are you avoiding investment in the development phase?
Or is that just the nature of the agreement with cloud? That you would wait until stabilization?
Sure. Thanks, Greg. Thanks for the question.
Without going into specifics of the cloud transaction, I think your first part of your question, was whether we would be interested in investing in Europe or outside The U. The answer is yes to that. You know, we are certainly in a lot of different countries now in Europe. there is some very good data center markets there as well, the FLAP cities plus some other emerging very attractive markets. That is absolutely something that we would be open to.
I think and as part of the cloud JV that we announced, as you saw that could present us with opportunities not only in The U. S. But also in Europe. Your question about, I think, cap rates and yields, and ties back into Sumit's earlier answer, it really is dependent on a country by country basis. I mean, cap rates can be different, asking cap rates can be different, but our cost of capital also varies by region, by country.
And so, hard to give you a definitive answer on that other than like everything else, know, depending on where, what country those data center assets might be in, we are going to you know, them and seek to get the same historical spreads and returns that we would normally get. And then in terms of investing in development phase versus post stabilization, Yes. Thanks.
Sorry, forgot about that part of the question. There are ways that we can, for example, we have and I think we have mentioned this, what led to our cloud JV and the 3 seed assets was actually by, lending, during the development phase of projects. And so, know, that is something that we can do.
We can play in different parts of, these phases of these assets. Not just, you know, with Cloud, but with other potential transactions as well.
Okay. Thanks. And then, on the loan investments, initial yields are up to 9.2% this quarter.
Is there anything in particular that was driving up that yield? And assuming a similar kind of rate environment going forward, are your expectations what are your expectations on turning those into real estate versus recycling that capital back into more loans?
Sumit Roy
President & Chief Executive Officer
It could have multiple reasons as to why we do the credit investments, Greg. You know, part of it is precisely what Mark was mentioning that it is a way for us to then have access to the real estate which is acting as the collateral in the development phase. And we are able to, depending on where we invest, able to get outsized returns depending on the risk.
That is associated with that investment. But the idea has always been that we will use credit investments to either have a channel to owning that real estate because that is 1 way to play it. Or to build relationships with operators that have a pipeline of assets that we are interested in.
More often than not, the investments that we are making is secured by real estate. Neale estate that we would love to own You know? And so that is the thinking and the thesis behind the deals.
If it is obviously a stabilized asset, the yields tend to be lower. If it is during the development phase, the yields are going to be higher. So that is definitely going to be a function of the inherent risk in those investments.
That will dictate what the yield is. Thank you.
Our next question today comes from Eric Borden at BMO Capital Markets. Please go ahead.
Greg, thanks. Just going back to the guidance raise, on the $02 at the midpoint. When you mentioned capital markets execution risk being been taken off the table, does that primarily relate to debt issuance or equity funding?
And cross currency financing? Or is just the overall funding visibility for the pipeline greater or increased?
The combination of all of that. Eric. I would say, obviously, debt financing, we have taken a lot of that risk off the table.
The European market, and the shape of the FX curve has been very beneficial to us. And importantly, you know, a lot of what we have done on the acquisitions and investment side is euro denominated. So we have had a net investment hedge capacity that can match fund the financing the same currency as where we are getting rent and where we are deploying our capital.
On the equity side, you know, you can see we have got $1.3 billion of unsettled forward equity. And, you know, that is at a reasonable price, but certainly that is a risk where you have initial guidance that you come out with in February you take for granted that you are gonna be able to have, you know, that type of equity cost. And then, you know, I would also say, just looking forward, part of it is also thinking about yields.
And if we have more visibility to the pipeline, in terms of volume, you can assume that we would have pretty good visibility in terms of yields, which translates directly into investment spreads. And so you know, I would say it is really a combination of all the factors that you mentioned there.
Thanks. And then just on the same store revenue growth of 1.2% in the quarter. With strength from the industrial and gaming sectors, but there was an offset of a 5.1% decline from the other bucket Just hopefully, if you could provide some more color on what is driving the underperformance in that category, whether it is specific asset type or tenant cohort?
Yeah. So, you know, when you look at the footnote in terms of other, you do see that we have added hotel to that category. And so, you know, the quantum itself is not meaningful, but I would say, it is an asset that you know, we assumed from a prior merger.
And, you know, we feel like we are coming to a good resolution on this, but, you know, there was a little bit of nonpayment of rent that we absorbed in the second quarter. Thank you.
Our next question today comes from Upal Rana at KeyBanc Capital Markets. Please go ahead.
Thank you. Sumit, on your updated investment guidance of $10 billion is that a reasonable annual deployment run rate we should be expecting for the company to achieve going forward? Not looking for any future guidance numbers, but just there were some larger investments this year.
So just curious if that is the level that we should expect going forward?
Sumit Roy
President & Chief Executive Officer
Well, Upal, in 2022, we did $9 billion. In 2023 or 2021, 1 of those years, we $9.5 billion. So, you know, this is the third year that we are forecasting to do north of $9 billion.
And all we have done is expanded our, you know, investable channels and we have expanded our geographies. So look, we are very comfortable guiding to 2026 at $10 billion and obviously, we have been very open about the areas that we would like to invest in. We have talked about once in a generational opportunity on the data center side.
Those are the things that I would ask you to consider. In terms of sourcing, we are sourcing, year to date, we source north of $62 billion. And this is very much in line with, you know, the all time high that we had in 2025.
And every year as we have expanded these investable channels and geographies, our sourcing numbers have gone up. So I mean, 1 could even make the argument if we had a better cost of capital things would be even simpler. But I am not going to go into, you know, whether $10 billion is the is the right run rate or not.
I can speak to this year being something that we are very, very confident about and very much believe in meeting. Okay. That was helpful.
And then just a quick 1 on the new client rent recapture rate. I know it only represents about 10% of the total re-leasing, but it was materially below the portfolio average. So just wanted to get your comments on what was driving that?
The 102.7% was materially lower than our guidance. I do not believe we gave guidance on recapture rates And so my team is showing me some numbers Oh, you are talking about with new clients. Correct.
I understand. So there were very few assets that went through to a new client. And Upal, what I would ask you to focus on is what is the blended rate that we are able to achieve.
For the right client, we are absolutely willing to give rent haircuts and enter into a you know, a longer term contract with more growth. Those are things that we will continue to play. And what we have said is we are a very mature highly effective you know, asset management business and those are going to be areas that you will see fluctuate quarter over quarter.
But what we focus on is when you take that into consideration along with re-leasing to the same client, what are we blending out to? You know? Is that a positive number?
And I would say that know, this 100 and almost 103% has largely been the case quarter in, quarter out since we have been tracking this number over the last 8, 9 years now. So that is something we talked about 10 years ago when asset management was not as big a part of our business. But today, what is it, Janine?
Close to $400 million of leases that are rolling on an annual basis. And it will be closer to $500 million you know, in the years to come. So it is very much a big part of our business, and it will continue to be a driver of growth.
And it is a team that I am very proud of. And, they continue to post amazing results for us. Thank you.
Our next question today comes from Jay Kornreich at Cantor Fitzgerald. Please go ahead.
Hey, thanks. Just 1 question for me on the private capital fund. You mentioned deploying the initial $1.7 billion of equity.
From the private core plus fund. So wondering just where do you go from here? Were there any limits or barriers that led to the initial raise being that $1.7 billion And then how should we think about the private capital fund growing in size from here?
Hey, Jay. So I think 1 way to think about it is you know, for a cornerstone raise, you know, that is when the when the big initiative is to build the AUM. And know, once you get that cap on the door and then you have proven that you can deploy it, accretively, You know, there is a performance track record that we are trying to build here.
And you generally need a 3-year track record until you can come back to the market and really open up the floodgates for more capital. I will remind everyone that, you know, Sue had mentioned earlier. Open end perpetual fund, which, you know, in the environment we have been in, you know, is not exactly the most, you know, active market fundraising standpoint.
We were able to buck that trend, but now the focus is on performance. And so I think where we go from here is there is a lot of focus internally on making sure that, you know, we are making all the right decisions should there be capital recycling. Obviously, deployment of the capital has been a big focus.
On the right deals, with the right underwriting, the right structuring. And so you know, we are constantly gonna be open for business in terms of trying to raise capital, but, you know, the expectation was always you get the cornerstone capital in the door. You deploy it.
You manage it. You show results. And then you know, 3 years in, that is when your next round starts to really take off.
Okay. that is helpful context. that is all for me.
And our next question today comes from Spenser Allaway with Green Street Advisors. Please go ahead.
Yes, thank you. As Realty Income continues to find accretive ways to grow, I am just curious how big you envision the credit platform could be as a percent of overall investment volume in any 1 given year. And then can you remind us, do you have a dedicated team looking for these credit opportunities?
Sumit Roy
President & Chief Executive Officer
I will answer your second question first, Spenser. Yes, we do. We had dedicated folks here in, in The US as well as in Europe looking for transactions on the credit side of the equation.
In terms of how big we would like for this to be, we do not again, just like there was a question on type composition and what we want data centers to be or industrial to be. Know, we view credit as a way to ultimately get to owning assets fee simple. That is how we are using credit to enhance relationships with developers, to cultivate relationships with developers, and gain access to the real estate that we have a long term view on.
And so today, it is a very small portion of our balance sheet. Circa $3 billion. it is our credit investments. And, you know, and we feel like it has allowed us access to channels that would not have been available to us had we not gone down this path.
And while we are investing, higher up on the on the balance sheet with better collateral you know, while generating yields that are quite compelling. And so if that leads to then owning real estate, I think it is a channel that we want to continue to lean into. But obviously, this is not something that is going to dominate our balance sheet.
We are not a lending We are not a lender. We are not a bank. But it is a way to sort of cultivate relationships that allows us to execute our core business, which is owning net lease assets, long term net lease assets.
Okay, great. And then maybe just circling back to the capital recycling. I know you provided a lot of great color around the direction there.
But it looks like you have sold more occupied assets this quarter as a percent of your total disposition. So just speaking to your more proactive asset management. I am just curious, is there any 1 credit or industry that drove elevated asset management in Q2?
Or was this just a slightly busier quarter? Yes. it is-- look, I hope that this trend continues. What you are gonna see, Spenser, is that it is could be a credit driven decision.
It could be a mispricing decision. That we see that the private markets are valuing assets at a much lower cap rate than what we would have on our balance sheet. We are not tied to any 1 asset.
If there is a massive mispricing that we are gonna see, we are gonna try to lean into that. We know where we want to put capital to work. If this could become a source of capital, that allows us to sort of reposition our portfolio in a way that is incredibly accretive we want to lean into that.
And so you should not just look at occupied sale as a way to reduce credit. That could certainly be you know, a reason to do that, but it is not the only reason why we would be selling assets, occupied assets into the market. Thank you.
That does conclude our question and answer session. I would like to turn the conference back over to Sumit Roy for any closing remarks.
Sumit Roy
President & Chief Executive Officer
Thank you so much, everyone, for joining this call, and we look forward to seeing you in upcoming conferences. Rocco, thank you for hosting us.
Yes, sir. Thank you very much. And we thank you all for attending today's presentation.
You may now disconnect your lines and have a wonderful evening.
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