Realty Income (O) Q1 2024 Earnings Call Transcript

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Realty Income (O -0.78%)
Q1 2024 Earnings Call
May 07, 2024, 2:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Realty Income Q1 2024 earnings conference call. All participants will be in listen-only mode. [Operator instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator instructions] Please note this event is being recorded.

I would like now to turn the conference over to Mr. Steve Bakke, senior vice president of corporate finance. Please go ahead.

Steve Bakke — Senior Vice President, Corporate Finance

Thank you all for joining us today for Realty Income’s first quarter operating results conference call. Discussing our results will be Sumit Roy, president and chief executive officer; and Jonathan Pong, chief financial officer and treasurer. 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.

You’ll disclose in greater detail the factors that may cause such differences in the company’s Form 10-Q. We will be observing a two-question limit during the Q&A portion of the call in order to give everyone the opportunity to participate. If you would like to ask additional questions, you may reenter the queue. I will now turn the call over to our CEO, Sumit Roy.

Sumit Roy — President and Chief Executive Officer

Thank you, Steve. Welcome, everyone. Our results for the start of 2024 illustrate our focus on thoughtful, disciplined growth and continue to demonstrate the consistency of our global operating and acquisition platform. We believe our value proposition to investors is a simple one.

Our demonstrated ability to generate consistent positive operational returns regardless of market volatility and economic environment. Our projected 2024 operational return profile of approximately 10%, which comprises an anticipated dividend yield close to 6% AFFO per share growth of approximately 4.3%, assuming the midpoint of guidance is a validation of our value proposition. To summarize the results from the quarter, we would highlight several key takeaways. First, diversification.

Diversification by geography, asset types, and client relationships. We believe our business model is unique in the real estate sector as we have optionality to grow in different regions with investments in a multitude of real estate products where we see superior risk-adjusted returns. During the first quarter, we invested $598 million at an initial weighted average cash yield of 7.8% across three property types: retail, industrial, and data centers. Over half of this volume representing approximately $323 million was invested in Europe and the U.K.

at an 8.2% initial weighted average cash yield. Investment volume in the U.S. was modest during the quarter. Of the $275 million of U.S.

volume, which was invested at a 7.3% initial weighted average cash yield all but $16 million was invested in previously committed development takeouts. This quarter’s bias toward international volume is a testament to the diversity of geographies we consider to allocate capital. To further elaborate, our investment volume during the quarter consisted of 87 discrete transactions with three transactions over $50 million, which speaks to the breadth of our platform. Our ultimate focus with any growth vertical or new region is to serve as a real estate partner to the world’s leading companies and to ensure the investment outcome matches the consistent risk-return profile of our investments, which have proven resilient over almost five decades as an operating company and three decades as a public company.

Second, the health of our portfolio remains solid across all key operational metrics. We finished the quarter with occupancy of 98.6%, consistent with the prior quarter and our projections. And we delivered another strong leasing quarter with rent recapture of 104.3% on the 198 leases that we renewed or released during the quarter. At quarter-end, our list of tenants on the credit watch list comprised approximately 5.2% of total portfolio annualized rent, which is in line with our historical average and with no individual client representing more than 1% of our total portfolio annualized rent.

Consequently, we would highlight the diversification of our portfolio, which, today, consists of over 1,500 clients in all 50 states, the U.K., and six other countries in Western Europe, all of which helps insulate us from potential disruptive interest rate and credit events that could impact the durability of our cash flow. Finally, our balance sheet and access to capital continues to represent a major competitive advantage and affords us significant flexibility to fund our business without the need for external capital. After the Spirit merger closed in January, our annualized free cash flow available for investments is approximately $825 million. This provides us significant organic investment capacity to finance our growth plans without being required to tap into the debt or equity markets to meet current investment guidance.

I would also note this also excludes any additional capacity generated by our disposition program, which I will discuss later. In spite of volatility in the capital markets, we posted a nominal first-year investment spread of over 340 basis points in the first quarter, which is well above our historical spread of around 150 basis points. The primary driver of these outside spreads is the significant portion of investment volume funded to free cash flow, which, by virtue of being a nondilutive source of capital, meaningfully reduces our nominal first-year cost of capital. To be clear, our investment decisions remain based on our long-term weighted average cost of capital, which considers only our cost of stock for equity and long-term 10-year unsecured debt.

This establishes the minimum return hurdle we seek to exceed across our aggregate investment activity. In all cases, our long-term WACC has exceeded our nominal first-year cost of capital with respect to our transactions. This long-term-oriented underwriting model is what drives our focus on acquiring high-quality real estate, leased to solid operators who are leaders in their respective industries because we believe these opportunities have significantly lower residual risk — value risk. In addition, to reach our longer-term growth hurdle rates, we are increasingly prioritizing meaningful contractual rent escalators in our leases with conservative rent coverage metrics that we believe will be even more resilient through a variety of economic cycles.

In summary, activity in the transaction market remains uneven. Many potential sellers of real estate remain sidelined given this uncertain interest rate environment, which is amplified by mixed inflation-related data over the last six months. Sellers remain reluctant to transact and the breadth and depth of domestic investment opportunities have compressed as a result. However, as experienced in prior cycles, we remain optimistic that the market will provide more opportunities in the second half of the year as the economic outlook becomes clearer.

Turning to portfolio operations. As previously mentioned, our recapture rate was 104.3% contributing to same-store rent growth of 0.8% in the first quarter. Excluding the negative impact from our Cineworld theater portfolio, following the lease amendments finalized late last year, our same-store portfolio was up 1.4%, largely in line with the contractual rent growth embedded in our portfolio. One of our competitive advantages in the marketplace is our asset management and real estate operations functions, consisting of over 80 individuals who we believe are among the most talented in the industry.

Since becoming a public company in 1994, we have now resolved over 6,000 lease expirations at a blended rent recapture rate of 102.5%, which is a testament to our acquisition underwriting, quality of our real estate, and the scale of our asset management and real estate operations teams. During the quarter, we sold 46 properties for total net proceeds of $95.6 million. Our recycling efforts are a function of a more active investment management initiative. Our active decision-making on dispositions is supported by our proprietary predictive analytics platform.

In recent years, we have harnessed the collective contributions of our predictive analytics team, the credit underwriting group, and the fundamental input from our asset management group to inform our acquisition strategy. We believe the combined benefits of these three groups provide us significant differentiation in the industry as a result of the quantum of data we have gathered across our portfolio over our long operational history. So, now, in addition to our acquisition program, we are using the data to more proactively manage the portfolio and guide our active disposition program. I will now turn it over to Jonathan, who will add further color to the quarter.

Jonathan Pong — Chief Financial Officer and Treasurer

Thank you, Sumit. It’s been a quiet start to the year on the capital markets front, following our January U.S. dollar bond offering, which raised $1.25 billion in gross proceeds at a blended yield to maturity of approximately 5.14%. As introduced in our prior earnings call, our financing strategy for 2024 does not require incremental capital to finance our growth and acquisition needs.

This continues to be the case at our current investment guidance. To that end, we had another quarter with a net debt and preferred equity, annualized pro forma adjusted EBITDA ratio of five and a half times. That’s in line with our target ratio. During the quarter, we settled approximately $550 million of equity previously raised through our ATM program and which was outstanding on a forward basis.

This leaves us with approximately $63 million of outstanding equity available for future settlements. And when combined with approximately $825 million of annualized free cash flow available to us following the Spirit merger, and the disposition program that Sumit referenced, our $2 billion investment guidance for the year is one we believe can be funded without having to tap the markets. Our debt maturity schedule for the remainder of the year is modest, with approximately $469 million of remaining maturities, excluding $342 million of short-term commercial paper and revolver borrowings and of cash. As always, we look to maintain significant financial flexibility to fund known and identified liquidity, and with approximately $4 billion of total liquidity available to us and minimal variable-rate debt exposure on the balance sheet, we believe we can refinance these maturities while still retaining significant liquidity headroom and keeping bad debt exposure well below 10% of our debt capital stack through the balance of the year.

With that, I’ll turn it back over to Sumit for closing remarks.

Sumit Roy — President and Chief Executive Officer

Thank you, Jonathan. In summary, the year is off to a solid start, that is in line with expectations. Our earnings growth profile for the balance of the year remains consistent with our outlook and earnings guidance we gave in February. The tempered pace of activity in the first quarter reflects our long-standing capital allocation discipline, and we will remain selective as cap rates adjust to the current rate environment.

In the meantime, the levers we can exercise from an internal funding standpoint, in particular, free cash flow and capital recycling, allow us to continue investing at spreads well over 200 basis points on a leverage-neutral basis. Our approximately 4% AFFO per share projected growth rate, paired with our estimated annualized dividend yield of approximately 6% is why we believe our platform offers one of the most compelling investment opportunities in the S&P 500. With that, I would like to open it up for questions.

Questions & Answers:

Operator

We will now begin the question-and-answer session. [Operator instructions] We request that you limit yourself to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. The first question comes from Nate Crossett with BNP.

Please go ahead.

Nate Crossett — Exane BNP Paribas — Analyst

Hey, good afternoon. I was wondering if you could just talk about the current pipeline. What does pricing look like so far into 2Q? Where is the pipeline weighted? And I know it’s a small sample size but pretty attractive yields in Europe in the quarter. Is there anything to note there?

Sumit Roy — President and Chief Executive Officer

Thanks, Nate. Good question. I think what you’re seeing here in the U.S. is largely a confusion around where the rates are going.

When will the rate cuts materialize and it’s a function of what we’ve seen play out over the last six months in terms of mixed data that is causing this confusion. And the way it’s manifesting in our space is this reluctance of sellers to transact at what is reflective of the cost of capital environment today. And so, for us, this is one of the advantages we bring to the table is we play in multiple geographies. and we are seeing much better risk-adjusted return opportunities in Europe today, where the data has been a lot more consistent, and therefore, the ability to transact with potential sellers much more real.

And that’s kind of the reason why you’ve seen 54% of the volume manifest itself in Europe versus here in the U.S. And I suspect, because your question was very specific around the current pipeline and what we think will happen in the second quarter, I suspect it will be a similar slant to the results. But I do believe that the second half of the year, we should start to see a lot more transactions materialize. I know that the team is actually in conversations with multiple potential sellers, but the disconnect happens to be where that reservation price is for potential sellers.

But we do believe that once the environment becomes a little clearer in terms of what’s going to happen with rates and when will those potential rate cuts come to fruition, I think the transaction market in the U.S. will catch up.

Nate Crossett — Exane BNP Paribas — Analyst

OK. That’s helpful. And then if I could just ask one on the tenant credit side. What’s on the watch list right now that we should be tracking and maybe you could speak to Red Lobster specifically because that’s been in the news recently.

Sumit Roy — President and Chief Executive Officer

Sure. So, you know, the ones that we currently have on our watch list, Rite Aid, that represents about 31 basis points of rent. It’s still going through bankruptcy. We are very hopeful that it will emerge from bankruptcy soon.

But like I said, it’s a very small portion of our overall portfolio. Joanne is another one that was on our — is on our watch list. That represents four basis points of rent, and our expectation is that all six leases are going to be assumed at 100% recapture just given the way they’re planning on emerging from bankruptcy. Every other name that’s on our watch list is sub-4% in terms of names that are currently in bankruptcy.

So, it’s a — it’s obviously a very, very small portion of our overall watch list. The ones that are not on — not currently in bankruptcy but continue to garner a fair amount of interest here internally is Red Lobster, the one that you just mentioned. We have about 216 leases. It represents 1.07% of our rent.

The cash flow coverage that we have across all 216 assets is right around two times, and 201 of these 216 leases happen to be part of a master lease. So, I just wanted to frame our exposure to Red Lobster before I go into some color around the name itself. I think of Red Lobster as — it’s a pretty strange story. They have 700 unique locations.

They garner 14% of the casual seafood concept. That is a very hard thing to do. And the fact that they generate north of $2 billion in revenue, if you look at it on a per unit basis, that’s just right around $3.5 million per unit. So, it’s not a top-line issue, as much as it is an operations issue.

They’ve gone through several changes in terms of ownership. Obviously, there have been several changes in terms of management. And this is a business that, in our opinion, hasn’t been very well run. If you look at the balance sheet, is it a balance sheet issue at Red Lobster? In our opinion, it’s not.

They have $220 million of debt, and this is really a question of, is there an operator out there that could come in and basically manage this business even to a reasonable level of margins? Today, I don’t believe they’re generating a whole lot of EBITDA. But having said that, you know, our 200 assets has two times coverage. So, that should tell you that we obviously have assets that are some of the best assets in their portfolio. And so, if this can be operationally rightsized, we believe that this is a concept that should come out, and should survive and do quite well, given the footprint that they’ve been able to establish.

So, that’s our view. We are keeping a close eye on it. As far as rents are concerned, we’ve collected 100% of the rents due to us as of May. So, it’s a wait-and-see, but it does happen to be on our watch list.

Operator

The next question comes from Greg McGinniss of Scotiabank. Please go ahead.

Greg McGinniss — Scotiabank — Analyst

Hey, Sumit. Are you able to provide more details on the active disposition program you’re talking about maybe in terms of targeted volumes industries or how you’re identifying assets for recycling?

Sumit Roy — President and Chief Executive Officer

Sure. Good question, Greg. So, what we are hoping to achieve is circa $400 million to $500 million of asset dispositions this year. We can’t be very precise around it because part of it is a function of the market.

We expect that the occupied sales and the vacant asset sales is going to be approximately 50-50. Obviously, in the first quarter, it was disproportionately vacant asset sales. I think $82 million of the $96 million was vacant asset sales, $14 million were occupied. But what we are trying to do is intentionally get ahead of some of these assets that happen to be on our watch list.

And not always is it being driven by a credit issue. Sometimes, it is purely a real estate issue that our asset management team has concluded, does not have a long-term position in our overall portfolio. And then there are certain trends that we are seeing that we want to try to get ahead of based on client conversations, etc., that is also going to allow us to be a lot more proactive and get ahead of situations well in advance of it becoming an issue downstream. In terms of the actual concepts themselves, it is along the lines of what we have been selling.

Some of it is automotive services. There are some drug stores that we believe are not part of the overall strategy. Some of it is going to be the Cineworld assets that, by the way, the sale process is going, I would say, ahead of what our expectations were. And then some that are perhaps not, like I said, core to what our overall strategy is on the discount store side as well that we want to try to get ahead of.

So, those are the components that will make up what we want to try to get disposed off this year.

Greg McGinniss — Scotiabank — Analyst

OK. And is that $400 million to $500 million the kind of entirety of the program? Is that a first step? And then how are you thinking about as that compares to the level of acquisitions that you’re targeting this year, what that might mean for growth in 2025?

Sumit Roy — President and Chief Executive Officer

Now, look, we’ve got to execute our plan based on what we believe is the right portfolio that’s going to take us into 2025 in a position of strength. We have grown our business through M&A. There have been two very large M&A deals done in the last two and a half, three years. We’ve been, I believe, very open about not all of those assets have been core to our long-term strategy.

And so, some of this is largely a function of trying to get back to that core portfolio. We have obviously underwritten the impact of 50% of circa $400 million to $500 million in dispositions being occupied assets. But what you’ll find is some of these assets are actually being sold. Look at what we sold or — and I know it wasn’t a big number, but the occupied assets, we actually sold them at a 7% cap rate, cash cap rate, and we are reinvesting it at 77%.

So, it is actually an accretive disposition strategy that we’ve been able to implement at least for the first quarter. So, for us, it’s about creating the portfolio that we want to go into 2025 and beyond with. And this is a program that will consistently be executed on going forward. When we are doing sale-leasebacks, it’s not an issue.

When we’re doing portfolio transactions on existing leases, not always do we get 100% of what we want. And so, being a bit more proactive around culling the assets that is not core to our overall strategy upfront is something that I think we are going to be a lot more intentional about. But we feel very good about our ability to continue to grow despite the strategy in 2025 and beyond.

Operator

The next question comes from Joshua Dennerlein of Bank of America. Please go ahead.

Unknown speaker

Hi. Good afternoon. This is Darryl on behalf of Josh. I was wondering if you could clarify how bad debt is currently trending.

I know you made some comments on the watch list. And perhaps if that has changed at all in your outlook of how much bad debt is baked into guidance?

Jonathan Pong — Chief Financial Officer and Treasurer

Hey, Darryl. On the bad debt number, so we did disclose in the earnings press release for Q1, it was about $1.4 million that we actually recognized. As we think about forward-looking guidance and downside scenarios. I think we’ve been pretty clear in the past that we’ve been extremely conservative.

I think when you sit here today, it’s early May, it’s a long time to go before the end of the year. It’s not to say that there’s any major concerns. I think you heard some talk about the watch list and it’s a bunch of small little things that if everything when a yes, maybe could have some impact, but it’s certainly not our expected scenario on that front. And so, I think it’s really a mix of spirits assets that we did acquire that we’ve always been a little bit more cautious on, and we’ll continue to be cautious until we get further into the year.

I think for us, we’re always pretty conservative as it relates to bad debt expense, especially early in the year. And then finally, there’s some identified credits that, you know, we’re even more draconian on.

Unknown speaker

Great. And second question about — given the cap rates that you’re seeing in Europe with coming off of acquisitions, has your thought process or thesis changed when you’re thinking about development and the yield you can get off that versus these straight-up acquisitions?

Sumit Roy — President and Chief Executive Officer

No, it’s a matter of timing, Darryl. You know, the older vintage developments start to roll off, you’ll start to notice that some of the newer developments that we’ve entered into are more reflective of the current cost of capital environment. and therefore, the cash cap rate yields that we are expecting on that vintage should creep up. It’s just that we entered into our development pipeline 12, 18 months ago.

And some of those assets obviously were more reflective of the environment that we were in at that particular point in time. But even at a 7.2% cash cap yield, which is what our development is — that closed in the first quarter yielded is still circa 150 basis points, 170 basis points of spread. So, yes, it’s not quite the $78 million that we were able to achieve on the overall and certainly not 8.2% that we were able to achieve in Europe. But that — I just wanted to make sure that you are aware that there is a bit of a lag on the development pipeline and the developments that we are entering into today is much more reflective of the environment today.

Operator

The next question comes from Brad Heffern of RBC Capital Markets. Please go ahead.

Brad Heffern — RBC Capital Markets — Analyst

Yeah, thanks. Hi, everybody. Going back to the European cap rates, it really felt like that market has lagged the U.S. for a long time in terms of recognizing the higher rate environment.

I appreciate the outlook has been a bit more stable over there. But is there anything else that’s changed in Europe that’s now generating these attractive cap rates despite the cost of debt obviously being lower than the U.S.?

Sumit Roy — President and Chief Executive Officer

Yeah. Brad, you know, the cost of debt is certainly lower in Mainland Europe. It’s not lower in the U.K. I would say trying on top of each other.

Jonathan’s nodding. So, the big difference that we see and why potential sellers are willing to transact at the yields that we were able to realize, they’re twofold. One, there are funds that have had redemption pressures where they need to monetize real estate, and they are more than willing to reflect what the current cost of capital environment is because they need the capital. And the second, which works really in our favor is the fact that we have established ourselves as the go-to buyer of these types of assets.

and recognizing that the surety of close, which is very important for these potential sellers is going to be met. And that reputation really does accrue to our benefit when we are sort of having these conversations, and somebody requires capital near term, and we have the ability to close on these transactions as and when we agree on a particular price. I think it’s those two factors that’s allowing us to be very successful in the U.K. and in Europe and how it’s playing out.

Here, unfortunately, you don’t have similar pressures. Yes, there could be operators that might be willing to transact. But if they have any ability to wait, which in the U.S., they have a lot more alternatives, they are sort of standing on the sidelines waiting for the environment to improve for potential buyers to then be able to get the cap rates that they’re willing to transact in. So, I think that’s how I would frame why we are being successful.

One of the reasons is obviously very idiosyncratic to us, and the other is it’s a reflection of the market.

Brad Heffern — RBC Capital Markets — Analyst

OK. Got it. Thank you for that. And then on Dollar Tree/Family Dollar, can you remind us what the Family Dollar split is? And talk about any impact that you might have from the closures.

Sumit Roy — President and Chief Executive Officer

Yeah. Look, I don’t think that the impact for us is going to be disproportionate. We have about 3% of our rent, that is Dollar Tree, Family Dollar exposed to Dollar Tree, which obviously is the owner of Family Dollar. And I would say about 60%, circa 60% is Family Dollar, and the rest of it is either Dollar Tree or the dual banners that they have.

There’s about I want to say 3% of the 3.3%. So, that’s nine basis points of lease expirations over the next two years, two and a half years that will materialize. So, even if there are these closures and even if some of these assets are named on the closing list, our impact is basically nine basis points. And I can assure you that our asset management team is already working on resolutions given that it is part of the pipeline.

Anything beyond that will potentially be closed and will remain dark. We are still going to collect rent. And let me tell you that the pressure on Family Dollar and Dollar Tree is going to be a lot more acute than it is on us. to try to find a substitute to step in and take over these leases.

And just episodically, there’s a fair amount of interest in some of these locations that we’ve received just along the lines of some of the news that’s out there about potential closings, etc., that we feel pretty good about our ability to resolve the Family Dollar assets. The one thing I’ll add, which may not be apparent, Family Dollar tends to be in urban areas and in much more densely populated areas than Dollar Tree or Dollar General. And so, the attractiveness of those locations to alternative retail clients is a lot more — and that’s borne out by the fact that we have received inbound. So, for us, this is no different than learning well in advance that, hey, these particular leases are not going to get renewed, and it gives us time to work on some of these leases well in advance of the actual lease expiration.

So, that’s how I would frame it.

Operator

Our next question comes from Michael Goldsmith with UBS. Please go ahead.

Kathryn Graves — UBS — Analyst

HI. This is Kathryn Graves on with Michael. Thanks for taking my questions. My first is — you touched on this a bit at the opening, but how are you thinking about — if you could maybe just provide some more color how you’re thinking about the cost of free cash flow within the context of your investment spreads?

Sumit Roy — President and Chief Executive Officer

Sure. That’s a great question. For us, free cash flow is a massive advantage. The ability to raise $825 million of free cash flow post all obligations is essentially capital that we can use to invest across a variety of areas to accretively grow our earnings.

Obviously, when we have free cash flow, we have to figure out what is the best use of that free cash flow. We could buy back our debt, we could buy back our stock, we could continue to invest accretively. And when we find that investing accretively is the best possible use of that capital — that is a massive advantage. And in a year where we are highlighting the fact that we have $2 billion of acquisitions, and we hope we do better than that, but that’s our current guidance.

Being able to finance this business with $825 million of free cash flow, which is obviously nondilutive in nature, and grow our earnings is a massive advantage. That’s how we think about our free cash flow. There is obviously opportunity cost associated with this. But the way we think about opportunity cost is what’s the best use of this capital.

And for us, even in this environment, given the platform that we have, and given the diversification benefits of being able to invest across multiple asset types across multiple geographies, we are continuing to find accretive use of this particular cash flow. And I think obviously, one of the other things that we do look at is what is the long-term overall return profile. And that is what we compare to our long-term WACC, which is our cost of equity, that 65%, and our cost of debt that is 35%. And the cost of equity — and by the way, we have a few pages on this in our investor deck.

It’s largely driven by the CAPM model and the dividend growth model. And I think we take the average of the two to come up with our cost-effective long-term cost of equity and the long-term cost of debt and it’s 65%, 35% weighted. And all of our investments need to meet that hurdle rate and exceed that hurdle rate for us to move forward. So, that’s really how we think about our cost of capital and how we specifically think about the free cash flow, which obviously we view as a massive advantage to us.

Kathryn Graves — UBS — Analyst

Got it. Thanks so much for the color. And my second question is on the development piece. So, do you expect to see an acceleration of yields for your development projects as we progress through 2024 or even into 2025?

Sumit Roy — President and Chief Executive Officer

We do. Any new development that we are entering into, and I think somebody asked this question as well, we should — it should be more reflective of the current cost of capital environment. And so, as you know, a lot of these developments, they do have a bit of a lag time. And so, what you’re seeing close today is in that lower 7% ZIP code.

But what you should see translate over the next few quarters is to see that cash cap rate continuing to trend much higher, reflecting the current cost of capital.

Operator

Our next question comes from Anthony Paolone of JPMorgan. Please go ahead.

Anthony Paolone — JPMorgan Chase and Company — Analyst

Thanks. First question relates to the Europe acquisitions in the quarter and the yields there. Can you talk a bit more about what kinds of embedded rent bumps are included in that? How much was maybe traditional net lease versus maybe multi-tenant assets? Because it looked like duration was a little bit on the shorter side.

Sumit Roy — President and Chief Executive Officer

Yes. So, a lot of these were retail parks. And let’s talk a little bit about retail parks because there’s a confusion when you say multi-tenanted, we think in terms of what — how we define multi-tenanted here in the U.S. This is not like multi-tenanted here in the U.S.

A lot of these are I would say 80% of them are Tier 1 or Tier 2 as we define them, clients that we are pursuing on a freestanding basis. And they happen to be located in a contiguous part. And each one of these units basically has a flow-through from rent to NOI, very similar to what you would find on a freestanding basis. So, the growth in these leases, they tend to be shorter, anywhere between five to 10 years.

And the growth in these leases could be open market reviews or they could have some of the larger boxes could have more of the regular way growth that we’ve seen that are tied to inflation, etc. But when we are underwriting these assets, we are looking at the composition of the tenants. We’re looking at the flow through. We’re looking at are these rents above or below market.

We’re looking at what the long-term profile of the return is going to be. And then we are comparing it to what are we getting these assets at Day 1 in terms of the initial yield. And these assets have really done very well. And some of the numbers, a lot of the renewals come strong, these retail parks that we bought because the freestanding assets haven’t gone through a renewal process yet.

And the fact that they are very similar in nature to our overall portfolio of 104.3% that we were able to generate this quarter is a reflection of how we are underwriting each one of these retail parks. But that’s where we are seeing the value. And the fact that we are now starting to consolidate and control swaps of retail parks across the U.K. is a massive advantage for us because the kind of conversations we can have with clients that we’ve obviously wanted to grow with is very different when we control major locations that they would like to continue to stay over the long duration.

And I think that’s how we are able to generate the value that we are able to generate. And we are doing it at a time point in time where should be told retail parks are starting to change. If you look at the vacancy that you have, it’s circa 2%. If you look at the actual growth that we are being able to generate, it’s much higher than what was traditionally achieved.

And if you also look at the free rent concept that used to exist, we are being able to compress on that concept, just given the fact that we control so much more of retail parks. So, this has been a great investment for us. And I just want to make sure that people realize that the flow-through is very similar to a stand-alone net lease business that we’ve traditionally been involved in. So, I’m glad you asked the question, Anthony.

Thank you.

Anthony Paolone — JPMorgan Chase and Company — Analyst

Thanks for all the color. And then just my follow-up is more on the credit side. You spent a bunch of time on that. But can you give us any updated thoughts on AMC, both as it relates to how you’re thinking about that credit as well as your specific assets with the box office being down a bunch this year?

Sumit Roy — President and Chief Executive Officer

Yeah. So, look, we’ve gone through one of them already with Cineworld. AMC represents about 1% of our rent. We have, I believe, 39 assets.

AMC continues to be able to raise capital in the equity markets. And 24% is not going to be a great year for the box office. We recognize that. It may be equivalent to last year, maybe it will be even a little bit less than last year given some of the disruptions that occurred in 2023.

But the expectation is that 2025 will supersede 2023 and the quality of movie releases will be much higher in ’25 than in ’24. Is it possible that AMC goes through a BK process? Yes, it’s absolutely possible. But I can tell you, our experience on Cineworld gives us a lot of confidence that the assets that we have and the resolutions that we’ve been able to achieve and the restructuring of the rent that was achieved is still going to create an outcome that is very acceptable to us. Tony, just to put things in perspective, our history, and we’ve had several bankruptcies in our history.

Our recapture rate has been north of 80%. And I believe if we were to do the full analysis, once we go full cycle on the Cineworld, it’s going to be in that ZIP code. And it’s not actually even better than that. given some of the resolutions that we are finding on the vacant asset sales that we had touched on last year on Cineworld.

So, I believe AMC is going to be a similar story, but it is not trade comp that they’re going to go through a BK process, we believe they have enough liquidity to certainly withstand this year and potentially most of next year as well. But if they were to go through a BK process, it’s not necessarily a bad thing. I think it will allow them to restructure the debt, which I think continues to be a massive burden and they will emerge stronger for it. And we believe that, again, just like in the Cineworld situation, we have some of their better assets and we will do fairly well even if they were to go through the BK process.

So, that’s our thoughts on AMC.

Operator

Our next question comes from Haendel St. Juste of Mizuho. Please go ahead.

Haendel St. Juste — Mizuho Securities — Analyst

Hey, good morning out there. Sumit, you mentioned thoughtful and disciplined growth selective a few times about your prepared remarks, clearly suggesting that the activity will remain subdued as you push the more yield and quality, but you did leave the door up in capacity in the gas a little bit more compelling opportunities to emerge in the back half of the year. So, I guess I’m curious maybe some more thoughts on that and how you think about balancing the pace of investment versus your longer-term earnings growth target if you’d be willing to push a bit more in the second half, even if that would make for a omit the right opportunities came along. Thanks.

Sumit Roy — President and Chief Executive Officer

Hi, Haendel. I’m sorry, it was very difficult to hear you. But I think what you’re asking for is, do we expect to accelerate the investments in the latter half of the year given what we are seeing today? And if I didn’t quite get that, I apologize. But the answer is, look, we are not trying to look for a particular quantum of acquisitions or investments, we are allowing for the market to dictate how much we’ll be able to achieve in a year, which is very uncertain.

If you’re asking for an opinion, I do believe that especially here in the U.S., the second half of the year, when there is a little bit more clarity in terms of where interest rates are going, etc., there will be more opportunities. And Haendel, if you look at what we’ve been able to achieve over the last few years, we tend to get more than our share of the volume, especially of the product that we are interested in pursuing. And so, is it possible that the U.S. acquisition numbers for the remainder of the year is going to be higher than what we achieved in the first quarter, the answer is yes.

We certainly do. Do we expect the European momentum to continue? The answer is, yes. Do we expect both these markets to accelerate? The answer is, yes. And I just want to caveat it that this is our opinion, and time will tell.

But we feel fairly optimistic about the second half of the year.

Haendel St. Juste — Mizuho Securities — Analyst

Thank you for that. And just a follow-up on Europe since we’re talking about it here. I think you have close to $10 billion or so, plus or minus, asset value there. So, I guess I’m curious if there’s any change or update on the thinking of a potential spin-off of that platform.

Is it large or mature enough? And maybe when do you think that it could be ready to stand on its in? Thank you.

Sumit Roy — President and Chief Executive Officer

That was a loaded question, Haendel, but thank you for asking. The number is, I believe, closer to $11 billion. Yes, if we were to spin that business out, it would be one of the largest REITs in the U.K. But that is absolutely not our intention today.

We are very happy with having Europe as part of our overall platform precisely for the reasons that we talked about on this call regarding the first quarter, it allows us the opportunity to play in markets where we have the best risk-adjusted return profiles of investments. And therefore, all of that benefit accrues to our shareholders here in the U.S. So, that’s how I’m going to leave it. Again, was this a grand design that we would grow up to $10 billion? No.

It’s again a function of the platform that we brought in, our cost of capital, our team and their ability to execute unlike any other teams, and our ability to form the relationships as quickly as we did, and now we consider the de facto net lease company in all of Europe. I mean, those are benefits that has taken us five years to establish. And now we feel like is the time for us to continue to harvest the benefits of establishing ourselves in Europe. So, that’s how I would answer it.

Operator

The next question comes from Nick Joseph of Citi. Please go ahead.

Nick Joseph — Citi — Analyst

Thanks. Given the opportunities that you’ve talked about in the better cap rates in Europe and kind of the thoughtfulness on the long-term weighted average cost of capital. How do additional data center and gaming investments look today on the U.S. side?

Sumit Roy — President and Chief Executive Officer

Thank you for your question, Nick. Yes, I would say about 6% of our investments in the first quarter went toward the digital JV that we have formed. As you may recall, Nick, that is an asset that is being currently developed in Northern Virginia, in Loudoun County. And it won’t be operational until the end of this year, the first phase, maybe — actually, it’s the first quarter of next year.

And then there could be the second phase that gets kicked in. So, as of right now, that is the only investment that we have on the data center side. There are other opportunities that we are looking at. We do have an investment that we will make, we will continue to make in Spain, that is also looking at a data center side that we believe is very well located, and there seems to be a lot of interest in that particular side.

That will be our additional spend on the data center side, but that hasn’t been substantial to date. But those are really the only two opportunities that we are looking at. We are obviously involved in multiple conversations with multiple operators to try to understand where the real opportunities are versus the optimism that continues to play out in this particular space. And we are hopeful that we can grow our high percent part of our portfolio in a meaningful way over the next few years.

But as of right now, a lot of it is just in the initial stages of conversations with potential operators outside of the JV that we have with digital.

Nick Joseph — Citi — Analyst

Thanks. And then just on the gaming side?

Sumit Roy — President and Chief Executive Officer

On the gaming side, things continue to look interesting. We’ve obviously made two investments. It represents slightly north of 3% of our rents, and we are in conversations with other opportunities, including potential development opportunities in large cities. There’s a very long tail to some of these development opportunities.

But we’ll see how some of these conversations translate into actual transactions. But I will say that there was an interesting conversation we were having earlier this year, which has been kind of put on hold for right now that would be a continued growth of our gaming business, but it hasn’t quite materialized yet. So, we’ll see how that plays out.

Operator

The next question comes from Wes Golladay of Baird. Please go ahead.

Wes Golladay — Robert W. Baird and Company — Analyst

Hi, everyone. You highlighted all the levers you have to pull. And when you created last year was the credit investment platform. Can you give us an update on that?

Sumit Roy — President and Chief Executive Officer

Yeah. Wes, we continue to look for opportunities on the credit investment side. But please keep in mind that one of the things that’s dictating our investments in the credit side is to continue to strengthen relationships with either existing clients or to help facilitate sale-leaseback with those existing clients. And if we want to be viewed as a real estate partner to some of the world’s leading operators, part of being that partner is to provide capital through the traditional channels that we have established or on a more secured basis to balance sheet lending.

And that continues to be how we think about our credit investment. But one of the advantages of doing this Wes, as I’m sure you recognize, is these continuous headwinds that we experienced given refinancings that we are having to incur at much higher rates. This is a perfect natural hedge to that because here we are lending to clients that we have credit exposures to reflective of the current higher interest rate. And that’s really part of why we believe that this is such a good strategy for us in the interim people talk about reinvestment risk.

Well, guess what, if the environment is different and interest rates actually go down. We don’t have to roll our credit. Our cost of capital should be better. these headwinds that we are facing on our refinancings will dissipate.

And we’ll be able to, therefore, invest it in more of our traditional sources, this capital that we get back at very good yields. And so, really, I think of the credit partly as a defensive mechanism and is a natural hedge to the headwinds that we faced, but also very much in line with trying to become that real estate partner to the world’s leading operators, and these are operators with whom we want to continue to grow our relationship.

Wes Golladay — Robert W. Baird and Company — Analyst

A quick follow-up on that one. So, when you talk about the natural hedge, would you look to keep these more SOFR-based loans?

Sumit Roy — President and Chief Executive Officer

Yeah. We do have software-based loans. But by and large, what we try to do is not expose ourselves to the floating rate element. We try to lock it in, we get it but then no longer becomes a perfect hedge.

But given where the environment is and given the expectation of interest rates, we are still very well protected. We have one loan, the Asda loan that was — it was — it’s a floater, and it’s off of the SONIA in the U.K. But largely, every other loan that we’ve made has been a fixed component to it. And keep in mind that we also inherited some loans, one of which actually got paid off and at 100% that we inherited from Spirit, and it was a $33 million seller financing that Spirit had provided to imagine, which, by the way, was an outcome that was superior to how we had underwritten it.

So, yeah, it’s good. Jonathan, do you want to add something?

Jonathan Pong — Chief Financial Officer and Treasurer

Yeah. Well, just to add to that, when we think about it in a natural hedge, I think it’s more so a lot of lines of lenders that actually matures because we look at our maturity schedule, we’ve got a decent amount of debt coming to well staggered, but on a nominal basis, still pretty significant $1.9 billion next year, for instance, or $3.26 billion at almost $3 billion in ’27. And so, when you have a corresponding asset that could get cold or will get repaid and it’s hard to replace that coupon in a lower rate environment, chances are we’re much better off as we’re refinancing our liabilities and our cost of capital is obviously much lower. So, I think that’s another way to take through the natural hedge element.

Operator

Our next question comes from Harsh Hemnani of Green Street. Please go ahead.

Harsh Hemnani — Green Street Advisors — Analyst

Thank you. So, not a good jump of acquisitions this quarter came from ones that needed the capital and some redemptions. How would you contrast that opportunity set for acquisitions versus maybe the traditional sale-leaseback market when realty income could provide a solution for tenant refinancings? It sounds like based on interest rate hopes of iterate going down, more tenants are looking toward the traditional credit market and trying to look for finite sources of capital rather than locking in sale-leaseback capital for a perpetual period of time. Is that something you’re seeing more so in tenant conversations today than compared to a year ago?

Sumit Roy — President and Chief Executive Officer

We are certainly seeing sale-leaseback opportunities. In fact, 13% of what we closed in the first quarter, it was sale-leaseback. But you’re right, Harsh. If you compare it to last year, 46% of everything we did was sale-leaseback.

The year before that, it was closer to 40%. And we are not seeing that. And I think part of it is because clients are trying to figure out ways to not necessarily lock into 20-year, 25-year leases at these elevated cap rates. And so, if there is an alternative available to them, be it through the debt markets, which has much shorter duration, even if it is higher, I think they’re going to be far more inclined to doing that.

But I just want to be very clear that we are — again, if it’s a brand-new client that we don’t have a relationship with, we are not going to go and provide them credit if there isn’t a compelling sale-leaseback opportunity with them and our desire to have them as part of our client restore is not there. We are not going to be pure credit providers like some of the credit funds out there that exists. So, I do see that changing as there is stability in the rate environment as people start to get much more comfortable about where things are going to sort of play out, I do believe that sale-leaseback will come roaring back. We are in discussions with some names right now.

And it really is a disconnect between where they want to transact and what — where we are capable of transacting given our cost of capital. But I think it’s a matter of time.

Harsh Hemnani — Green Street Advisors — Analyst

Thanks for that. I’ll leave it there.

Sumit Roy — President and Chief Executive Officer

Thank you, Harsh.

Operator

And our next question comes from Linda Tsai of Jefferies. Please go ahead.

Linda Tsai — Jefferies — Analyst

Hi. Thank you. Maybe piggybacking off Greg’s earlier question on dispositions. Your proprietary predictive analytics platform will be used to help with dispose.

Could you just give us some more color on how that works? What are some of the inputs to the analysis?

Sumit Roy — President and Chief Executive Officer

Yeah. That’s where the secret sauce is, Linda. But all right. Let me — and I don’t want to get too pedantic, so try to keep it pretty high level.

The way our predictive analytics work, it is by industry and even at times by client. But largely, the models work by industry. And it tries to identify the key variables, which could be 20, 30, 40 variables that dictate the predictability of a renewal outcome or a leasing outcome. So, the pieces around how we created the predictive analytic tool was to figure out what was our leasing activity going to look like where will we — the risk was defined as, are we going to be able to maintain the rent that we currently have during a renewal period? Or are we — is it going to go less? Or is it going to be more — and that’s how we define risk, and that’s how we’ve sort of created these algorithms by industry to identify where does risk lie in our portfolio? And as you can imagine, each industry has its own set of variables that dictate that particular outcome.

But the biggest piece of all of this. I think the creation of the algorithms, etc., is a fairly simple task. I mean, it’s taken us three and a half, four years. So, I don’t want to minimize that piece.

I’ve got me looking at me strangely here. But it is the data that we have that allowed us to back-test these models and continue to refine and calibrate these models to improve their predictability. I think that’s what is whether the true value lies in our platform, having been around for 50 years. And I think that’s why you see the kind of results that you see when we are posting the release — the releasing spreads, when we are trying to get ahead in terms of identification of assets that we should, where we are maximizing the return profile of those assets given what we think will happen some lease renewal.

I think that’s where the predictive analytics tools, along with the asset management team was using on-the-ground experience to sort of share their perspective along with the credit view, that group together is what’s dictating how we try to stay ahead with the portfolio. And it’s — it has to be tools driven. It has to be technology-driven. When you have 15,400 discrete locations within 80 different industries with 1,500 different clients, I mean, it can’t be done manually.

And so, that’s the reason why we chose to make this investment, Linda, five years ago and several millions in — you know, this is a tool that we are very, very proud of, and it’s now very much part and parcel of every decision we are making. Be it acquisitions, be it disposition, the hold decisions, and also, this tool is now being used to dictate the highest and best use for potential vacancies, which may or may not be the old use of that particular asset. And we’ve seen some of the value creation that that prediction has yielded for us as a platform. So, hopefully, I didn’t get too much into the details, but that’s really how the predictive analytics tool works.

Linda Tsai — Jefferies — Analyst

Appreciate the color. And then just in terms of using dispose to get back to that core portfolio you referenced earlier, can you give us some metrics or characteristics of what that looks like? You have more international exposure versus four or five years ago? How does that kind of fit to the core portfolio?

Sumit Roy — President and Chief Executive Officer

Yeah. For us, having geographical diversification, the advantages of it played out in the first quarter, right? I mean, you saw we were able to find transactions in the U.K. that had a return profile that far superseded what we are able to find here in the U.S. And then that will flip — so I think the geographical diversity is a good thing.

In terms of the actual composition of the portfolio, we clearly have what we are viewing as an optimal portfolio. and an optimal portfolio, we might like, let’s call it, grocery. But we want grocery to be 13% to 14% of our overall portfolio. If that creeps into the 19% to 20%, that’s not a good thing.

And by the way, I’m giving you an example, that’s not the case. Grocery happens to be only 10% of our portfolio today. And then there are other areas like apparel that we may not necessarily want to be exposed to at all. But again, using very broad brushes across particular subsectors is not the right answer either.

And that’s the reason why this tool, along with credit, etc., they help us devise what we believe to be the optimal portfolio. If you think retail and you step back, we like service-oriented businesses. We like low-price point businesses. And — that’s sort of the overarching nondiscretionary overarching elements that we look for on the retail side.

That doesn’t mean that we won’t deviate from this. But over 90% of our retail portfolio, by the way, has one or more of these characteristics. But that’s, I think, how you think about the composition and geographical diversification is something that sits on top of that.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Sumit Roy for any closing remarks.

Sumit Roy — President and Chief Executive Officer

Thank you all for joining us today, and we look forward to speaking soon and seeing you at the upcoming conferences. Thank you.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Steve Bakke — Senior Vice President, Corporate Finance

Sumit Roy — President and Chief Executive Officer

Jonathan Pong — Chief Financial Officer and Treasurer

Nate Crossett — Exane BNP Paribas — Analyst

Greg McGinniss — Scotiabank — Analyst

Unknown speaker

Brad Heffern — RBC Capital Markets — Analyst

Kathryn Graves — UBS — Analyst

Anthony Paolone — JPMorgan Chase and Company — Analyst

Haendel St. Juste — Mizuho Securities — Analyst

Nick Joseph — Citi — Analyst

Wes Golladay — Robert W. Baird and Company — Analyst

Harsh Hemnani — Green Street Advisors — Analyst

Linda Tsai — Jefferies — Analyst

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