O - NYSE

Good day, and welcome to the Realty Income Third Quarter 2025 Earnings Conference Call. [Operator Instructions]. Please note today's event is being recorded. I would now like to turn the conference over to Andrea Behr, Director, Corporate Communications. Please go ahead.

Thank you for joining us today for Realty Income's 2025 Third Quarter Operating Results Conference Call. Discussing our results will be Sumit Roy, President and Chief Executive Officer; Jonathan Pong, Chief Financial Officer and Treasurer; Neil Abraham, President, Realty Income International; and Mark Hagan, Chief Investment Officer. During this conference call, we will make statements that may be considered forward-looking statements under federal securities law. The company's actual future results may differ significantly from the matters discussed in any forward-looking statements. We will disclose in greater detail the factors that may cause such differences in the company's filing on Form 10-Q. [Operator Instructions] I will now turn the call over to our CEO, Sumit Roy.

Thank you, Andrea. Welcome, everyone. Realty Income's platform, which is 56 years in the making, is a historically proven income generator with the ability to perform through a variety of economic conditions. The data-driven nature of our model, accompanied by decades of institutional experience and our top-tier talent, positions us to capitalize on an ever-increasing investor appetite for consistent long-duration income given aging global demographics. Additionally, our scale and diversification, spanning over 15,500 properties across 92 industries and more than 1,600 clients provide strategic proprietary data insights that position us advantageously comparative to subscale platforms. Recently, we have seen an acceleration in capital formation for net lease vehicles in the marketplace, and we believe our platform is especially positioned to benefit from capital floors yearning for long-duration income. As we establish ourselves in the private capital arena, our long track record of producing equity-like total returns with bond-like stability is resonating with investors. We recently launched a perpetual life fund and expect that initiative will provide additional capital to support our growth objectives and enhance our liquidity position. Turning to our operating results for the third quarter. Our investment activity continues to reflect the multiple levers of growth we have at our disposal. Our addressable market is sizable, enabling us to look at opportunities substantially free from geographical property or industry constraints. This allows us to pursue the most optimal risk-adjusted returns for our shareholders and to pivot with ease when we identify capital allocation opportunities that others might be unable to execute on. Globally, we invested $1.4 billion at a 7.7% weighted average initial cash yield, equating to a spread of approximately 220 basis points over our short-term weighted average cost of capital. This brings our total year-to-date investment volume to north of $3.9 billion, surpassing the investment volume we completed in all of 2024, excluding the Spirit merger. This quarter, we sourced $31 billion in volume, resulting in a selectivity ratio of 4.4%. This brings our total year-to-date sourcing volume to $97 billion, eclipsing our prior high watermark for annual source volume of $95 billion reached in 2022. This is a testament to the size of our addressable market and our visibility to global net lease transaction opportunities given the breadth and depth of our platform. Turning back to our investment volumes for the quarter. We again leaned into Europe, which accounted for approximately $1 billion or 72% of our investment volume at an 8% weighted average initial cash yield. The European investment opportunity continues to screen more favorably on a risk-adjusted basis relative to the U.S., which has become increasingly competitive from smaller platforms competing for similarly sized transactions. In contrast, the European investment opportunity remains compelling, driven by a fragmented competitive landscape a larger total addressable market than the United States, and a current cost of debt for euro-denominated 10-year notes that is approximately 100 basis points inside of U.S. dollar costs. Since entering the U.K. market in 2019, our disciplined underwriting and balance sheet strengths have enabled significant expansion across the continent, with Europe now representing almost $16 billion in gross asset value and approximately 18% of our total annualized base rent. Transitioning to the U.S, we invested $380 million at a 7% weighted average initial cash yield. While transaction volumes have moderated domestically, this reflects selectivity, not a lack of opportunity, as we continue to prioritize long-term risk-adjusted returns over pace of deployment of capital. Moving to our operations. The third quarter reflects the structural advantages of our business model, including portfolio diversification, which mitigates exposure to idiosyncratic credit risk and supports advanced data analytic capabilities. To that point, our proprietary predictive analytics AI tool developed over the past 6 years informs decision across sourcing, underwriting, lease negotiations and capital recycling. We believe this allows us to be proactive operators and reinforce the reliability of our long-term cash flows. As of quarter end, our portfolio comprised over 15,500 properties spanning 92 industries and more than 1,600 clients. The naturally defensive nature of our essential retail-oriented portfolio, including grocery and convenience stores, combined with our scale and diversification, position us to perform through a variety of economic environments. We ended the quarter with 98.7% portfolio occupancy, approximately 10 basis points ahead of the prior quarter. During the quarter, our rent recapture rate across 284 leases was 103.5%, representing $71 million in new cash rents, with 87% of leasing activity generated from renewals by existing clients. And we remained active in our approach to optimize the portfolio. In the quarter, we sold 140 properties for total net proceeds of $215 million. During the quarter, we sold 18 convenience store properties for approximately $55 million at a blended 5.5% cap rate and a weighted average remaining lease term of 11.3 years. This pricing is approximately 75 basis points lower than where we are acquiring portfolios of superior assets. This transaction reflects strategic portfolio optimization, first, by leveraging our scale to acquire assets at a portfolio discount and then by monetizing more mature properties individually at tighter cap rates. The sale allowed us to redeploy capital into superior opportunities and demonstrates our ability to unlock value through selective dispositions. Finally, we recognized $27.3 million or approximately $0.03 per share of lease termination income during the quarter. We realized such income in situations where our asset management team, in conjunction with input from predictive analytics, determines that lease termination presents the best probability weighted risk-adjusted net present value outcome. While we do not guide to this line item, we have added historical lease termination disclosure at the bottom of our consolidated income statement in our supplemental. The purpose of the disclosure is to add improved transparency on the separate and inherently different revenue streams of base rent and termination income. Overall, the stability of our results continue to demonstrate how the benefits of our platform enable us to stay agile, manage risks effectively and drive long-term portfolio performance. Now moving to our outlook for 2025. Given the continued momentum in our acquisitions pipeline and our progress year-to-date, we are increasing our 2025 investment volume guidance from $5 billion to approximately $5.5 billion. In addition, we are increasing the low end of our AFFO per share guidance, now anticipated to be in the range of $4.25 to $4.27. As discussed previously, our guidance contemplates approximately 75 basis points of potential credit loss, most of which results from certain tenants acquired through public completed M&A transactions. Our credit watch list remains manageable and granular, staying flat to the prior quarter at 4.6% of our annualized base rent and with median client exposure of just 2 basis points. With that, I will turn it over to Jonathan.

Thank you, Sumit. Realty Income has a proven track record of providing equity-like returns with bond-like stability. The inherent consistency of our earnings has allowed us to produce predictable leverage metrics as well. We finished the third quarter with net debt to annualized pro forma EBITDA of 5.4x, a fixed charge coverage ratio of 4.6x and $3.5 billion of liquidity. Additionally, only 6.5% of our debt at the end of the quarter was variable rate, all coming from our revolver and commercial paper program. Subsequent to quarter end, we closed on an $800 million dual-tranche unsecured debt offering, with a blended tenor of 5.3 years and weighted average yield to maturity of 4.4%. Most of the proceeds were used to repay $550 million of unsecured notes that carried a coupon of 4.6%, and we are pleased to execute on this offering amid historically tight spreads in our secondary curve. As always, we thank our loyal fixed income investors for their continued support of our platform and their long-standing appreciation for the relative safety of our business and its consistent production of predictable cash flows. As of today, we also have approximately $1 billion of unsettled forward equity which we believe is sufficient to fund all of our external equity capital needs to fund our investment volume guidance for 2025. I would now like to hand back to Sumit for closing remarks.

Thank you, Jonathan. We believe that the structural advantages we've cultivated, including scale, diversification, discipline and data analytics, will continue to create value through a range of economic backdrops. Looking ahead, our focus remains on operational consistency and disciplined investment principles that have guided us throughout our 56-year operating history. Our long-term objective remains unchanged, deliver resilient and growing income through a diversified net lease platform. With meaningful scale and strategic flexibility, we believe we are well positioned to remain selective in today's environment and deliver lasting value for shareholders over time. I would now like to open the call for questions.

[Operator Instructions] Today's first question comes from Brad Heffern with RBC Capital Markets.

Sumit, you talked about Europe continuing to be the preferred market, and at least part of that was attributed to higher competition in the U.S. Is that something that you're starting to see as more structural? Or do you think the relative attractiveness and preference between those 2 markets will continue to swing back and forth?

Well, it is a fact that there are more competitors here in the U.S. than in Europe. As you know, Brad, if you just look at the private side of the equation and the recent capital formation that's focused on net lease investing by Blackstone, BlackRock, Starwood, there's a whole series of new entrants into the market. So it is patently true that there is more competition here in the U.S. For us, it's a combination of what is available, which, by the way, we continue to source -- of that $31 billion that we talked about, the majority was sourced here in the U.S. It's not a lack of product. But the more competition that you have chasing the same products, we have to then sort of overlay where do we have the best value adjusted, risk-adjusted return profile. And that continues to push us in the direction of Europe, which is why you saw us do 72% of our investment volume there. If you look at the situation going forward, I would say that, that should continue. The majority of what we are seeing will continue to be in Europe, but we are starting to see some level of momentum here in the U.S. as well.

Okay. Got it. And then you obviously held the initial closing for the Core Plus Fund. Can you talk about what you've acquired in the fund so far and how that differs from the acquisitions you've completed outside the fund?

Yes. So Brad, unfortunately, there's very little I can share with you outside of what has already been disclosed. As you can see from our supplemental, we have increased the disclosure on what is going into the fund versus what's staying on balance sheet. Given the fact that we are currently in the marketing stage of our open-ended fund, we are very limited in what we can share with regards to the fund. But what we've tried to complement is give you more disclosure, and hopefully, you'll find this additional disclosure in the supplemental helpful in terms of your modeling, et cetera.

Our next question today comes from Michael Goldsmith at UBS.

This is Kathryn on for Michael. My first question, so similar to the second quarter, the majority of your dispositions were vacant assets, and I'm just wondering if you can provide some color on the re-leasing process. So specifically, who are the buyers? What was the downtime for some of these assets? And how does that compare to the remaining assets that you're looking to sell? And then maybe just sort of the spread of the different categories of assets that you've been selling down.

Yes. So Kathryn, this is very much part and parcel of a continuation of what we started doing in 2024. We talked about a similar quantum of disposition that we are going to achieve this year, and the makeup of that should be along the lines of what we had in 2024. Clearly, if you look at year-to-date, there was more vacant asset sales, but we did say that the back half of the year was going to be a bit more of occupied asset sales. And so that mix will continue. For us, it really comes down to us taking a look at a particular asset and deciding whether the lineup that we have of alternative clients who could step into that asset -- what is the return profile we could generate based on what they're willing to pay in terms of rent versus what are the proceeds we are able to get when we are selling these assets vacant. And in terms of -- and we are indifferent as to which path we follow. Our only criteria is where do we maximize the economic returns on that particular asset. And that really is what's determining when do we sell a vacant -- asset vacant versus trying to find a new client to retenant that particular asset. And so the fact that we sold 100-plus vacant assets was part and parcel of our strategy, saying that we were better off selling those assets and then reinvesting the proceeds in the current environment than we were holding the assets, incurring the holding cost and then tenanting it to a new client. So that was really the rationale. The makeup of that is across the board from casual dining, quick service restaurants, home improvement. It's across the board in terms of what we have sold, drugstores. And it really is a function of assets that are coming up for renewal, what is the expected outcome and whether we are better off selling the assets vacant. And so that is part and parcel of our strategy and will continue to drive how we think about disposing assets and recycling the capital.

Got it. That's really helpful. And then my second question is you mentioned the predictive analytics platform, and I'm just wondering if you can comment a bit about how you expect that to help reduce G&A in the longer term and just how you sort of expect to maybe be able to use that to imply a few labor efficiencies and other components that could help bring down G&A in the longer term.

Yes, Kathryn, that's a great question. So let me talk about the AI strategy in twofolds. I'll specifically answer your question on predictive analytics. This is a tool that effectively uses machine learning to continue to refine the outcome of this -- of its ability to predict renewals, et cetera. And this particular tool continues to learn every quarter, right? We are going through lease expirations every quarter. The model predicts a particular outcome. We check that outcome against what actually happens. And more often than not, the model is correct, north of 90% of the time in a lot of cases. And then where it isn't, it tends to learn from that particular error by modifying its -- the internal workings and the algorithms of the particular model. So that's how the model actually continues to become better and better at predicting at a much higher level of certainty what the outcomes are going to be. And this model is utilized when we are underwriting transactions on the front end, when we are making decisions on the asset management side as to whether we should hold an asset or dispose of an asset. It is also very much used when our asset managers are negotiating with our clients, where we have a high level of confidence going into a negotiation that this is a particular location that is actually doing very well. And that level of confidence obviously translates into the results that we talk about, the re-leasing spreads, et cetera. So that's one piece of it. And that particular model is more utilized as a tool to help complement the years of experience that our team has to make better decisions. The scale benefits will come from other AI implementations that we are doing, where we are using tools like PredictAP, for instance, is a perfect example where we had individuals doing -- basically getting invoices, tracking the invoices, inputting the invoices into Yardi, et cetera. All of that initial front-end stuff is now being done by an AI tool called PredictAP. And so that's where you were starting to get the scale benefits and personnel are shifting from doing clerical work to doing more quality assurance and doing approvals to make sure that the coding has been done correctly and the verification of that coding is being sort of validated by personnel. And that's where you're going to start to see -- and examples like that, which we are running through across the organization with various different tools under consideration, that's where you're going to start to see scale benefits of implementing AI tools. And we are at various different stages of maturity, depending on which particular department we look at and the kind of AI implementation that we are going to be doing. But this is a -- it's a journey that we are on, and the benefits of which will be realized by the company in years to come. But this is something that we are very focused on and something that we are very excited about embracing.

And our next question today comes from Smedes Rose at Citi.

I wanted to ask you a little bit about the loans you made in Europe in the quarter. It looks like you found some very healthy opportunities on the yield side. Can you share maybe who those were with and if you would expect to see significant opportunity in that kind of arena over the next quarters or so?

So Smedes, as we've said, when we started going down the credit investment path of one of the verticals that we wanted to sort of lean into, there was a strategic rationale behind it. We were -- what we had shared with you was we were already long the clients. We were doing 15-year, 20-year sale leasebacks with these clients. And we were long the credit. We were very comfortable the credit. And so our ability to be viewed as a one-stop shop, a true capital provider across the balance sheet for some of these clients was something that we wanted to lean into, and that was the makeup of the entirety of the loans that we did in the third quarter, so with existing clients that we are very comfortable with, and we are higher up on the capital stack. We have a lot of collateral that underlies these loans, and we are able to generate a higher yield. And the added benefit of doing credit investments in an environment where you have elevated rate environment is the fact that we do have about 6%, 7% of our own balance sheet that is exposed to floating rate debt, and so -- which acts as a headwind for our financing. And so to be able to take advantage by investing in credit investments with elevated yield, again, a function of the rate environment that we find ourselves, helps mitigate some of this -- some of these headwinds. So for a variety of reasons, this is an avenue that we will continue to lean into, but we are going to be selective. The idea here is ultimately to create closer relationships with our clients, and the hope is that it leads to more sale-leaseback opportunities with this client, which, by the way, was the case in the third quarter in 1 of these loan investments that we made, where we ended up doing an off-market $100 million sale leaseback as well.

Okay. That's helpful. And then, Jonathan, I just got to ask you on the guidance. So you talked about these higher lease termination fees that, I guess, we wouldn't have been expecting at that level. Is that -- what's driving down, I guess, or the implied decline in your same-store rentals through the balance of the year? Or are those totally separate issues?

Smedes, I would say the same-store calculation is separate from the lease terminations. The lease terminations are onetime in nature. I would say if you're trying to back into kind of a like-for-like excluding lease terminations, AFFO run rate, I think there are some offsets, obviously, that come into play for the back half of the year predominantly on the G&A side, which we view as just an investment in the future of this company and expanding the competitive mote that we benefit from. And that takes dollars. That takes head count. That takes technology, process improvement, et cetera, et cetera. So I would say the reason why you're not seeing that flow through in Q4 on the AFFO run rate is really investments in that realm.

Our next question today comes from Jana Galan with Bank of America.

Sorry, just one more follow-up on the lease term income in the quarter. Can you discuss whether this was 1 or 2 larger tenants? Or is this a mix of tenants?

It was predominantly one tenant, and it's something that is really a function of our asset management team's proactiveness and getting ahead potential move-outs and potential credit issues. And so this is something that you're going to see as part of our regular way business, maybe not to the extent that we saw in Q3 but certainly more active than we have historically. In 2024, we recognized about $16 million in lease termination fees already year-to-date. We're at around 30. And so on a go-forward basis, maybe we'll be closer to that 20-ish area. But with more churn, with more proactive asset management activities, I think you're going to see this be more of a regular way occurrence going forward but perhaps not as drastic as what we saw from one client in particular in Q3.

And congrats on a very active sourcing quarter on the investment side. I saw the allocation of new clients, leases as a percent of the leasing then tick up to 13%. I was hoping you could maybe discuss kind of what industries or segments those new relationships fall into.

Jana, we certainly did have a few new clients join our portfolio, certainly some in Europe. There were some logistics deals that we did that introduced some new clients into our portfolio. They tended to be, by definition, some of the larger investments we've made. But I wouldn't read too much into the fact that this particular quarter we had a larger number of newer clients than in previous quarters. This is more a function of as we are becoming more entrenched in Europe, we are starting to see new clients that we are cultivating relationships with. And they may be new to us, but they've been around for many, many years in these markets. And so we -- that was the whole purpose of going into a market like Europe, where it's green fields ahead for us. And so that really is the makeup of what we ended up doing in the third quarter. But I wouldn't read anything more than, okay, new relationships means better repeat business possibilities going forward.

And our next question comes from Anthony Paolone with JPMorgan.

Not to beat a dead horse on this lease term income, but just trying to understand like how much revenue, like annualized revenue do you kind of give up taking the lease term right now. Can you maybe help us with that?

Yes. Anthony, as you can realize, again, we're doing the math, and we are saying these are clients who will certainly pay, and despite what Jonathan said, in some cases, there might be credit issues that we are forecasting down the road that we want to take advantage of. But that was not necessarily the case in this particular client's situation. But if we are able to get the vast majority of the rent upfront and continue to cultivate a stronger relationship and solve an issue for our particular client because these are locations that are not doing as well as most of their other locations are, it's a win-win. So that was the case. When we structured this lease termination, we are coming out, in our opinion, ahead of what would have happened had we collected the rent for the remainder of the term. And then we would -- we were sure that they were going to not renew the lease and then looking at the landscape of, okay, who are the alternatives that could come in and comparing that to, okay, getting it vacant today, collecting the lease termination and selling it and recycling that capital is a far better outcome for us and better for our clients than just staying passive and collecting rent. We could have easily done that and we would have been just fine. But the economic outcome wouldn't have been as favorable, in our opinion, as it turned out to be taking the lease termination, solving an optimization problem for our client and reinvesting that capital.

Okay. Got it. And then just my follow-up. Sumit, you mentioned about, I guess, private equity and other private capital being more competitive in the U.S. market. Can you maybe just give us a little bit more color around maybe what kinds of assets you see them going after or what the impact on cap rates maybe has been? Or is there a certain segment of the market that, that just kind of keeps you out of?

I wouldn't say it's any segments that it's keeping us out of. What I am sharing with you, Anthony, is -- you know of these capital formations. These companies exist. Some of them have gone so far as to tell you exactly the strategy that they're going to be following. Some are fairly small. So by definition, they're going to go after the one-off market, and it's going to be across the spectrum on the lease -- on the net lease side. So from investment grade, lower cap rate deals with growth, that tends to be industrial. You're not going to have a whole lot of retail investment-grade, low cap deals that have a lot of growth built into them to higher yielding retail assets with growth. And that's what they've defined as their area of expertise. Some are basically focusing on build-to-suit industrial assets, which they feel like they can strike longer-term deals with a lot of growth in them. And in this environment, those are -- that's their very well-defined, clear strategy. Others are playing retail across the spectrum of credit, so it's -- you'll find them more in the one-off market than you would in these very large-scale sale leasebacks that we are tending to pursue here in the U.S. Having said that, we absolutely look at the one-off market and where it makes sense and where we have a relationship and where people are showing us transactions that are not marketed or not heavily marketed. We act on those. But it is patently true that you have more investors in net lease today than you did a year ago. And this is not a function of more public companies. It's a function of what's happening on the private side.

And our next question comes from Ronald Kamdem of Morgan Stanley.

This is [ Jenny ] on for Ron. Two quick questions. First one is same-store revenue growth of 1.3% year-to-date, but the guidance suggests 1% in 2025. So does it suggest a deceleration of same-store revenue in Q4? Like how should we think about it?

[ Jenny ], I wouldn't necessarily say it's a massive deceleration. The guidance number continues to be approximately 1%, but there is obviously a fair amount of conservatism when you still got 3 months ago because any type of bad debt expense does roll into that. And so even though we're not seeing anything material show up, that's why we kind of hedge a little bit from that perspective. Q3 also benefited from the theater industry. We did recognize some percentage rents that took that theater same-store number into the 5% area. And so that's something that will obviously moderate back down or at least from a modeling standpoint, that's how we're modeling it for the fourth quarter.

Perfect. That makes sense. Second question is I noticed the IG client represent like 31.5% as of 9/30 versus 33.9% in June. Like maybe comment a little bit on like what's driving the change? Like which tenant kind of moved out? Or, yes, just what's driving the change would be great.

It wasn't moving out. It was simply Dollar Tree selling Family Dollar. And Dollar Tree remains an investment-grade company, but Family Dollar is now a private company, and that no longer has the investment-grade rating associated with it. So I believe Family Dollar represents circa 2% of our tenant registry. And so that's the delta between the new number that you're seeing in our supplemental versus what you're comparing it to in the second quarter.

And our next question comes from Jay Kornreich from Cantor Fitzgerald.

Just a question on -- I saw that the investment yields for Europe jumped to 8%, so just curious if there's any key investments that you could call out or different types of assets maybe that you're investing into that commanded higher yields. And is this something that is sustainable to get these upper 7% or 8% yields going forward?

Yes. So Jay, obviously, what's blended into that number, that 8% number is circa $380 million of investments that we did on the credit side, which had a profile closer to 9%. And so you blend that in with what we did on pure investments on the real estate side, which is circa 7.3%, that's the blend that gets you to that close to 8%. But it was largely being driven by these higher-yielding credit investments.

Okay. Appreciate that. And then for the re-leasing rent recapture rate, which has been 103.5% throughout 2025. Now as you look at the lease expiration schedule going forward and bumps up a bit starting in 2027, are these levels of recapture rates something that you think you can continue to get in those forward years and provide a boost to revenue?

Jay, I can't comment on anything in 2027, in the future years. But what I will tell you is the way we are thinking about being a lot more proactive on our asset management side, if you look at what we've achieved in the last 3, 4, 5 years, it has been well north of 100%. And the average since we've been tracking re-leasing spreads has been slightly above 100%. It's been 101%. And so more recently, that number has gone up largely because we become a lot more active on the asset management side of trying to get ahead of situations that could result in degradation on this recapture rate. So the expectation and hope is that we will continue to be north of 100%. And this active -- proactive, I would say, implementation by the asset management team, we hope, will continue to generate favorable results.

And our next question today comes from Haendel St. Juste with Mizuho.

This is Ravi Vaidya on for Haendel. I wanted to ask a bit more about the AFFO guide for 2025. It looks like there were a couple of onetimers with the lease term fees, and you also raised the investment volume. I guess, why take down the high end of the AFFO guide at this point? Are there any offsets, maybe tenant credit or anything else that you might have considered as part of that?

Ravi, I think as we sit here today in November, we want it to be more precise. And I think the track record that we've had recently is we'll start relatively wide, and then we'll narrow as we get greater and greater visibility into some of the puts and takes. And so that's really what it is right now. The higher end of guide, I think at this junction, we feel is probably a less likely one if you're looking at just deal volume because, at this stage, a lot of that deal volume we're just projecting to be December or towards the later end of Q4, so very little impact. I'd also say from a seasonality standpoint, there are some expenses that come through a little higher in Q4, and that's certainly in our projection. And I think leasing commissions is certainly one of them that might be a little higher in Q4 than it was for the first 9 months of the year and then obviously, as I mentioned earlier, a little bit higher run rate on cash G&A. But that's really yet to flag.

Got it. That's helpful. Just one more here. How do you think about your balance sheet here and the ability to generate maybe better AFFO growth into 2026? Are there any -- because right now, we have stronger investment volume, better cost of capital. Are there any other headwinds that we should be aware of or think about as we think into '26 growth?

Yes. So I think the big refi that we have coming up is about a $1.1 billion multicurrency term loan in January. That is just shy of 5% right now. We have pretty good visibility in being able to refi that at a lower rate, and so that should be one tailwind that if you ask maybe 6 to 9 months ago, I wouldn't have expected it to be a tailwind. And so that's certainly a positive on the European side of the house. We make a big deal about how we're leaning into the continent. And a lot of that is really fundamentals that we see good risk-adjusted returns, but also a lot of it is euro-denominated debt offers us the lowest cost of debt in the capital stack. And so you can issue 10-year European debt at 3.9%. That can obviously be quite a bit of a tailwind and support your investment spreads. But we are not going to over-lever and issue more debt than we have assets that can offset that liability. And so that's going to be really driven by how much we can source and how much we can source in European currency so that we can issue that 10-year very attractively priced European debt. I think in terms of leverage ratios overall, we're at 5.4x right now. And if you look at really what we've done over the last however many years, going back at least 3, 4 years now, we've been extremely disciplined about staying within that, call it, mid-5% area. The A3- credit rating is incredibly important to us, and I think the regularity and really the very, very thin volatility that you see in that metric is testament to our commitment. And so you're not going to see us utilize more leverage in order to generate faster AFFO per share growth.

And our next question today comes from Spenser Glimcher with Green Street Advisors.

And just in regards to your comments on competition here in the U.S., your advantage of scale really comes into play with the larger sale leasebacks and the portfolio deals you mentioned. Are you just not seeing as many of these large deals where that advantage of scale can be leveraged?

Well, we did see one, and we talked about it in the fourth quarter of last year, where it was north of $700 million in sale leaseback, and all of the advantages that you just laid out, Spenser, sort of played out for us. But yes, seeing $1 billion transaction sale leasebacks here in the U.S., we haven't seen as many. And that doesn't mean that those discussions are not taking place. There are some pretty interesting transactions that are going on. But it's not something that happens every quarter. And those are specifically the types of transactions where we will be able to lean into our advantages. We are seeing a lot more transactions in size in Europe, and that's why we are able to do what we are able to do.

Yes, that makes sense. Maybe with that thought and with the greater competition you're seeing here in the U.S., would it be fair to say that your growth in the U.S. or maybe even Europe is going to be dictated a little bit more by the composition of deals more so than in the past?

The composition of deals, yes, I think that is precisely the way to think about it. That doesn't mean that we won't see a quarter where we are back to doing the majority of the transactions here in the U.S. But it will be a function and the types of transactions that are available that we believe creates the best risk-adjusted returns on a relative basis. Those are the ones that we are going to pursue. And I think that is one of the advantages of the Realty Income platform, is the fact that we have so many different swim lanes to evaluate, and we are seeing opportunities across all of those different swim lanes. And so it just so happens that a lot of what we have done year-to-date, more than 2/3 of the transactions, has been in Europe, which is where we have seen the best risk-adjusted returns. But again, I think if you unpack the sourcing numbers, the majority of the sourcing is still here in the U.S. U.S. continues to be a very active market, is when you then start to look at the individual transactions and you do the analysis and you say up on a relative basis, there are better transactions in Europe, then that's where we're going to invest.

And our next question today comes from John Kilichowski with Wells Fargo.

Jonathan, maybe if we could just go back to the question earlier on the guide. You talked about the high end of the AFFO guide. Just thinking about maybe where the midpoint was and where you all came in at. There was the $0.03 of the termination fee that we've talked about. So what was the offsetting [ 2 ] to get you to plus 1 versus the quarter? I know G&A is a little bit higher. Nonreimbursables are a little bit higher. Is there anything else that we're -- that I should be thinking about?

Yes. It's those 2 areas. Plus, the leasing commissions, as I mentioned earlier, tends to be a little higher in Q4. Just from a forecast standpoint, that is an AFFO deduct. And so that's one thing to maybe be on the lookout for Q4. I'd also say there's always going to be very short-term headwinds when you are doing the right thing for the long term. Sometimes that's vacant dispositions. It was a record quarter for vacant dispositions for us in this past quarter. And so rather than just taking any type of re-leasing spread just to keep someone in there, I think, moving on disposing and recycling that capital is really something that maybe, on a very short-term basis, could result in small dilution. But that's really it. It's nothing that I would flag as a significant item one way or another. It's a little bit of everything here.

Okay. Very helpful. And Sumit, apologies if I missed this in the opening remarks. I know sometimes you will say this. But could you give us where your watch list stands today and then maybe how bad debt has performed relative to expectations?

Sure. So it is the same as the second quarter, 4.6%. So it was 4.6% at the end of the second quarter. It's the same. And the other comment I had made in the prepared remarks was that if you look at the main of who makes up this particular watch list, the exposure is 2 basis points. So it's very granular in terms of the makeup of this watch list, and so any one client is going to have a very minimal impact in terms of the overall impact. In terms of year-to-date bad debt expense, it remains the 75 basis points that we came out with, and we are continuing to track to that. And we feel like we are -- our latest earnings guidance reflects that 75 basis points. So there's no change there.

Our next question today comes from Linda Tsai with Jefferies.

On capital allocation, would it have been more accretive to utilize free cash flow for your loan book and then not buy the other $1 billion of properties using equity?

Explain that a bit more, Linda. I'm sorry.

Just meaning if you use your free cash flow for lending purposes and then just refrain from buying as much by raising equity.

Yes. So we obviously have circa $200 million of free cash flow that we're generating every quarter, and that is part of the mix of proceeds available for investments. And when we have a menu of investment choices, we are looking at which particular investment is most favorable. And obviously, if we are raising public capital either via the ATM on the equity side or debt side, we are trying to see, are we better off not raising that capital, using our free cash flow to buy back our stock, which, by the way, we have the ability to do, versus investing it in opportunities accretively, those are decisions that we are making constantly. And so Linda, obviously, we chose to make $360 million worth of credit investments. We have the ability to do a lot more. But again, we are looking at what is the risk of making those investments for the returns that we are getting and getting comfortable with it within the construct of what we've said, we're going to make credit investments in, which is with clients that we believe we want to be viewed as their long-term real estate partners and with whom we can have the opportunity to do more sale-leaseback opportunities. So I'm not 100% clear if I've answered your question, Linda, but never are we going out and trying to invest capital in a dilutive fashion. I mean that is precisely why even -- and I think I shared this in the second quarter, and I'll share it with you now. There was about $2 billion of investments in the third quarter that we could have made had we the right cost of capital. And it was because we couldn't generate that initial spread, accretive spread, we chose not to pursue it. So we are being super selective in terms of what we are doing. And part of the reason why we've gone down this private capital to figure out an alternative form of capital to help us continue to invest was to be able to do things like the $3.6 billion that we had year-to-date in the first 2 quarters and another $2 billion that we would have loved to have invested in the third quarter.

My second question is on lease term fees. Was that -- thanks for the disclosure. Did you include that in your earnings guidance?

Yes. So it's -- everything is included, Linda. So our latest earnings guidance is reflective of all of the lease terminations, the bad debt expense and any other expectations that we have inclusive of the increased acquisition guidance that we've come out with this quarter.

Our next question comes from Upal Rana with KeyBanc Capital Markets.

I just want to get a clarification on the investment guidance increase. Does that include the fund investments? Just trying to get an understanding of how we should break down the investment guidance between the core portfolio and the private fund.

Yes. So definitely, we've given you that guidance and that disclosure in the supplemental. I know it's a new form supplemental. We, by the way, love to get feedback on it given that we have now entered into a new area of our business. So you will be able to see precisely what portion of total investments is going on balance sheet, what portion is going towards the fund, what is our pro forma. All of that will be, I hope, very clear if you just go through the supplemental, and I recognize that you guys haven't had too much time to digest that. So please go through it. The idea here is to make your lives much simpler in terms of modeling. But everything that you just asked, Upal, you should be able to figure out from the disclosure, which we hope is very clear. And we've tried to mimic others to come up with this disclosure. But if there's feedback, please do come back to us.

Okay. Great. And then appreciate all the color on the guidance so far. But could you talk about the other adjustments in your guidance? It increased by $0.04, but it didn't really help the -- increase the full year AFFO guidance. So just trying to get a better understanding of what other adjustments are and what drove the guidance change there.

Upal, are you talking about the AFFO guidance? And so I think we've talked about the AFFO guidance, the puts and takes, where the midpoint of our guide is unchanged. And really, the bridge to think about with that is, yes, we picked up about $0.03 from lease termination fees, but there were some offsets to that, predominantly leasing commissions, G&A and unreimbursed property expenses that I think are offsetting some of those gains.

And our next question today comes from Wes Golladay with Baird.

Just a quick one on debt capacity when you look to the Europe and U.K. How much more can you borrow out there assuming no more investments as of today?

Wes, we're pretty much right where we need to be from a euro standpoint. And so that's going to be driven by incremental volume. There's no unused capacity at this junction. We do have some European commercial paper that's outstanding, and so any type of issuance in longer-term debt financing will really be to term that out. But in terms of net new debt capacity, we're really going to follow the lead of the volume side of things from here. On the U.K. side, we're at about 75% LTC right now. And so we do have some capacity there on the GBP side. With that, we're going to continue to wait for a better opportunity all in at cost or a bit elevated there compared to the 2 other currencies we're exposed to.

And our next question today comes from Eric Borden of BMO Capital Markets.

I just wanted to talk quickly about the disposition program. I know over the last couple of years, you've really ramped that up as you look to recycle maybe vacant or less desired assets and reinvest into better opportunities. But just curious, as we look forward, is this going to be a bigger part of the picture? Will it remain the same quantum? Or should we expect that to tail off in the subsequent years?

So obviously, I don't want to give guidance, but what I can tell you, it's not tailing off. This is very much part and parcel of our business going forward. Part of what I do want to share with you is there was some debate around our portfolio discount. And what we wanted to make sure that we were able to share with the market with facts, not our impressions was to recycle some of our assets. And I think I gave you that disclosure in my prepared remarks, to continue to emphasize that when we are able to recycle capital, part of it is to realize this inherent portfolio discount that we see when we are doing large-scale transactions. And so that is much more strategic. But then there are other things that we are going to be doing that is continuing to expand just given that our denominator has expanded over the years that -- where we are being a lot more proactive in terms of recycling assets be it on the occupied side or be it on the vacant side, where rather than holding it for a year, 1.5 years, to try to find that one client that we anticipate we'll find but at rents that don't make sense for us versus recycling the capital today, taking into account the holding costs associated with these assets. So this is purely an economically driven analysis that we are going through. And with our ever-increasing portfolio size, you can expect recycling to be very much part and parcel of our strategy going forward.

Great. And then my second question is just on the data center opportunity front. I understand that there's a tremendous demand in the United States but curious if you're seeing similar or increasing demand in Europe, where you may be able to achieve better pricing or be able to close quickly or acquire these assets just given it's a more fragmented landscape.

So yes, Eric, we are very much focused in Europe as well. Data centers continue to be very much part and parcel of our investment strategy going forward. Some of the biggest developers here in the U.S. are also some of the biggest developers in Europe. And so when we are cultivating these relationships, making certain investments to further align ourselves with these very large-scale developers, it's not just on products here in the U.S. but on potential products in Europe as well. So I think we are -- we're very happy with where we are today and the relationships that we've formed, and we hope that it will translate into future transactions. And yes, some of it will be in Europe, and a lot of it will be here in the U.S.

That concludes our question-and-answer session. I'd like to turn the conference back over to Sumit Roy for any closing remarks.

All right. Rocco, thank you again for your help, and thank you, everyone, for joining us. We look forward to seeing you in some of these upcoming conferences. Take care.