Realty Income Corporation (NYSE:O) Q2 2022 Earnings Conference Call August 4, 2022 2:30 PM ET
Company Participants
Sumit Roy – President and Chief Executive Officer
Christie Kelly – Executive Vice President, Chief Financial Officer and Treasurer
Jonathan Pong – Senior Vice President-Corporate Finance
Conference Call Participants
Michael Goldsmith – UBS
Nick Joseph – Citi
Connor Siversky – Berenberg
Haendel St. Juste – Mizuho
Brad Heffern – RBC Capital Markets
Wes Golladay – Baird
Joshua Dennerlein – Bank of America
Ronald Kamdem – Morgan Stanley
John Massocca – Ladenburg Thalmann
Chris Lucas – Capital One
Harsh Hemnani – Green Street
Linda Tsai – Jefferies
Operator
Good afternoon and good morning. And welcome to the Realty Income Second Quarter 2022 Earnings Conference Call. All participants will be in a 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 now like to turn the conference over to Andrea Bayer [ph], Manager of Corporate Communications. Please go ahead.
Unidentified Company Representative
Thank you all for joining us today for Realty Income second quarter operating results conference call. Discussing our results will be Sumit Roy, President and Chief Executive Officer; and Christie Kelly, Executive Vice President, Chief Financial Officer and Treasurer. Also joining us on our call is Jonathan Pong, Senior Vice President-Corporate Finance, together with our One Team leaders.
During this conference call, we will make certain statements that maybe 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 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
Thank you, Andrea. Welcome everyone. Cultivating strong and enduring relationships with all our stakeholders is foundational to the success of our business. And I’d like to thank everyone, listening for your continued support. Additionally, I would like to express my appreciation to all my Realty Income colleagues who continue make significant contributions towards our growth initiatives, while serving our clients and all stakeholders as one Realty Income team.
We are pleased with the momentum across all areas of our business amidst an uncertain macro environment, which we believe once again, demonstrates the stability of our business model and its ability to thrive irrespective of the economic cycle. The strength of our global investment pipeline has allowed us to invest over $3.2 billion in high quality real estate in the first half of the year, including approximately $1.7 billion during the second quarter. Given this momentum, we are increasing our 2022 acquisitions guidance to over $6 billion.
On the topic of acquisitions. I’d like to mention two key developments that we are observing in the marketplace. First, as demonstrated by the weighted average 5.7% cash cap rate, we were able to achieve on our investments in the second quarter, cap rates are moving higher in our target markets. Our second quarter cap rate ticked higher compared to the 5.6% and 5.4% cap rates we achieved in the previous two quarters.
The positive correlation between cap rates and interest rate is also evident in our acquisition pipeline. Second, as a corollary to rising debt and equity costs that have impacted much of our competition, the pipeline of acquisition opportunities materializing for us at accretive spreads continues to grow.
As a reminder, we report our cap rates on a cash basis. On a straight line basis, we estimate our second quarter cap rate to be approximately 6.2%. And generally the difference between cash and straight line cap rates ranges between 50 and 70 basis points in any given period. Transaction flow remains strong with sourcing volume totaling approximately $26 billion in this quarter, bringing year-to-date sourcing volume to approximately $60 billion.
We remain selective as we have acquired approximately 5% of sourced volume year-to-date. During the second quarter as percentage of revenue, approximately 39% of acquisition volume was leased to investment grade rated clients. We remain committed to our underwriting principles of partnering with well capitalized clients who are leaders in their respective industries.
Our international investment volume continues to comprise a significant percentage of our total volume, representing 41% of global volume in the second quarter at a cash cap rate of approximately 5.8%. We are encouraged that our size, scale and access to well priced capital provides us with the platform and currency to actively deploy capital as we build continued momentum heading into 2023. It was also an active quarter with regard to dispositions.
We sold 70 properties generating net sale proceeds of $150 million at an unlevered IRR of approximately 9.3%. Year-to-date, we have sold 104 properties with net sales proceeds, totaling $272 million, generating an unlevered IRR of approximately 9.4%. Capital recycling continues to be a value accretive activity for us. And importantly, the unlevered returns we have been able to deliver, speak to the attractive risk adjusted investment profile of our properties that have gone through our full investment cycle.
Our diligent underwriting process, exposure to high quality credit clients and the inherent quality of our real estate continue to deliver consistent performance. At the end of the second quarter, our occupancy was 98.9%. The highest occupancy rate we have achieved in over 10 years. Based on our current occupancy rates and client profile, we are increasing our year-end 2022 occupancy guidance to over 98%.
During the second quarter, we re-leased 193 leases and achieved a rent recapture rate of 105.6%, bringing our year-to-date recapture rate to 105.9%. At quarter end, 43.2% of our portfolios annualized contractual rent was generated from investment grade rated clients. Further our properties leased to clients on our portfolio watch list represents less than 4% of our portfolios analyze contractual rent, which is largely consistent with the low percentages we have seen so far this year.
Finally, our same-store rental revenue increased 2% during the quarter and 3% year-to-date. With a continued strong operations performance of our portfolio, we are increasing our guidance for same-store rent growth to approximately 2% for 2022.
At this time, I’ll pass it over to Christie, who will further discuss results from the quarter.
Christie Kelly
Thank you, Sumit. During the second quarter, our business generated $0.97 of AFFO per share, representing 10.2% year-over-year growth. The growth engine of our Company revolves around accretive acquisitions. Our investment goals are supported by our well capitalized balance sheet and favorable cost of capital, which remain competitive advantages for us in the net lease industry.
We finished the quarter well within our target leverage ratios with net debt-to-annualized adjusted EBITDAre of 5.3 times or 5.2 times on a pro forma basis, giving annualized effects to net investment activity during the quarter. It was another active quarter for us on the capital raising front. As we issued approximately $1.8 billion of long-term and permanent capital, including nearly $1.1 billion of equity through our ATM program and a £600 million private placement note offering which priced at a weighted average fixed interest rate of 3.22% with a blended tenure of 10.5 years.
As a result, we finished the quarter with approximately $1 billion of commercial paper and revolver borrowings net of cash. Our outstanding CPE and revolver borrowings essentially represent our only variable rate debt exposure across a total debt principal balance of almost $16 billion.
As Sumit mentioned previously, our ability to access well priced capital is a competitive advantage. And we took steps during the quarter to further bolster this capacity. As previously announced in April this year, we recasted and upsized our multicurrency revolving credit facility from $3 billion to $4.25 billion. Subsequent to quarter-end, we upsized our U.S. Commercial Paper Program from $1 billion to $1.5 billion and established our Euro Commercial Paper Program with a capacity of $1.5 billion. The combined $3 billion Commercial Paper Programs for which our revolving credit facility serves as a liquidity backstop will give us the flexibility to efficiently finance our short-term funding needs at materially lower rates than comparable facility borrowings.
Given the momentum we continue to see in our investment activities in Europe, the establishment of a Euro program was a strategic goal of ours this year. And it will serve as an efficient tool for us to take advantage of the comparably lower all-in commercial paper rates in the Euro market. With the health of our portfolio and investment progress achieved year-to-date balanced alongside the timing of capital deployment and continued capital markets volatility. We affirm our previously announced 2022 AFFO per share guidance of $3.84 to $3.97 representing nearly 9% annual growth at the mid-point.
From a dividend perspective as the monthly dividend company, consistent quarterly increases in dividend reflects the confidence we have in the cash flow generated capacity of our business. In June, we increased our dividend for the 116th time in our company’s history. And last month, we declared our 625th consecutive common stock monthly dividend.
From a sustainability perspective, further in June, we published our green bond allocation report, and I’m pleased to report that the net proceeds from our inaugural green bond offering have been fully allocated to eligible green projects in accordance with the criteria outlined in our green financing framework.
From a merger perspective lastly, I am pleased to report that we have completed the integration of our VEREIT merger, which culminated in the conversion to a single ERP system for the combined entities during the second quarter. This could not have been accomplished so seamlessly without the commitment and dedication of our talented one team. And finally, we remain on track to achieve the expected $45 million to $55 million of annualized run rate cost energies we initially shared over a year ago when we announced the merger.
And now, I would like to pass the call back to Sumit.
Sumit Roy
Thank you, Christie. Coming off a record 2021 from an investment standpoint, I’m proud that our team has only accelerated the momentum this year. Most importantly, we believe the future is bright as our positioning to further gain market share in the investment arena grows. Indeed, the advantages afforded to us given our size scale and access to well priced capital have rarely been more pronounced than they are today. And we look forward to continuing to capitalize on this in the days ahead.
At this time, we can open it up for questions. Operator?
Question-and-Answer Session
Operator
We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Michael Goldsmith with UBS. Please go ahead.
Michael Goldsmith
Good afternoon.
Christie Kelly
Hi, Michael.
Michael Goldsmith
Thanks a lot for taking my questions. Hello, good. Thank you for taking my question. First question is on cap rates moving higher, the markets getting a little bit better. You have a larger acquisition team due to the VEREIT merger. How can you be a little bit more aggressive or take advantage of the improving markets, just given that combined with there are some uncertainties in kind of the borrowing markets as well.
Sumit Roy
That’s a good question, Michael, because there are competing variables in this market today. You’re absolutely right. That cap rates are moving in the right direction. There are adjusting a lot quicker than I had originally anticipated. We do have a much bigger team and with the VEREIT merger, some of the team members that we have inherited, they are definitely producing and focusing on a certain area of the high real market that is actually resulting in transactions for us.
The offset to that, however is the capital market. Look on a relative basis, we are doing very well. If you look at our tenure unsecured bond spreads, they have moved, I would say approximately 85 basis points. You look at our peers, our net lease peers we with a BBB rating, it’s moved 120 basis points to 150 basis points. If you look at our cost of equity, it is essentially unchanged from the beginning of the year.
But if you look at our net lease peers, they’ve dropped by about 1.8 times. So those are the positive momentums, but it is true also that our cost of capital overall has also increased. And the question really is around, can we generate the right spreads to move the needle on the overall AFFO per share growth? And the answer is yes. But as you know, there is an adjustment period, which is why we have increased our acquisition guidance to over $6 billion from over $5 billion as a testament to what we are seeing in terms of benefits accruing to us, based on some of what I just discussed, we are starting to see a lot more transactions coming back to us those that we were not willing to price at the levels that the sellers were expecting when they initially brought it to us, are now coming back with an adjusted cap rate, which works.
It is also true that the overall team has been able to just source more and those are sort of shown in the sourcing volumes that, that we have shared with you of $60 billion year-to-date. But with interest rate movements and more importantly, the velocity at which these interest rates have moved. The spreads continue to be right around at 110 basis points, 111 basis points year-to-date, which is slightly below our overall average. So that’s the reason why that this positive momentum is being reflected in higher acquisition volume, but not necessarily translating into higher earnings guidance.
Michael Goldsmith
Very helpful. And then as a follow-up, European acquisitions were about 40% this quarter. And so that represents a bit of an acceleration from what we’ve seen. So is 40% kind of the right mix for next year or at least the second half into next year like how are you thinking about the U.S. versus Europe mix going forward?
Sumit Roy
Yes. Michael, it fluctuates. I mean there have been quarters actually where the international acquisition number has been not the 50% of the overall volume. And as we start to grow into newer markets, et cetera, obviously the total addressable market continues to increase for us. And as we become much more mature in each one of these newer markets, the sourced volume as well as which translates to closed volume will increase.
But I wouldn’t go so far as to say that, at this point in time, we should be thinking anything north of this 40% number 41% is what we achieved in the second quarter, as being it should be the guiding composition of the overall acquisition numbers going forward. There will be quarters where we’ll do more just like we’ve done in the past but 40% seems to be the right number.
Michael Goldsmith
Thank you very much.
Sumit Roy
Thank you, Michael.
Operator
The next question is from Nick Joseph with Citi. Please go ahead.
Christie Kelly
Hi, Nick.
Nick Joseph
Thank you. Hi, how are you? You touched on cap rates obviously expanding a bit. Wondering if you could break that out between international versus the U.S. where you’ve seen more expansion, where you’ve seen more stickiness or any differences between the two.
Sumit Roy
Sure. That’s a great question, Nick. And welcome back to our space. I would say that the movement in cap rates here in the U.S. are certainly much more pronounced than what we have seen in the international markets. And it is largely a function of the Fed being a lot more aggressive than the ECB or the Bank of England have been.
Having said that, we just saw an announcement earlier today that the Bank of England has moved its interest rates 50 basis points. So we do see that translating to higher cap rates in the UK, as well as in the rest of Continental Europe. So just to quantify some of these movements, I would say that depending on the product, and when I say retail, you can go from groceries, which have moved the most because they had become the most aggressive, they’ve moved up about a 100 basis points to some of the other industries that we focus on within the retail space, I would quantify that movement is being right around 25 basis points to 50 basis points.
And you should start to see that being reflected in the subsequent quarters and the acquisition cap rates – cash cap rates that we are going to share with the market going forward. In the – in Europe, we have also seen movement, but it hasn’t been quite as pronounced maybe 5 basis points to 10 basis points.
On the industrial side, the movement has been a bit more visible 25 basis points to 50 basis points, similar to what we experienced here in the U.S. But I would say the industrial market has continued to see an expansion on cap rates. And I would say, from beginning to end, maybe you circa 50 basis points of movement on average. Now, obviously, there are certain markets where the movement has been a lot, lot less than that, and then Empire comes to mind. But the more secondary tertiary markets you have seen a more pronounced movement than it could be even north of 50 to 75 basis.
Nick Joseph
Thanks. That’s very helpful. And then you mentioned deals coming back, do those fall out of contract, did they – did the seller just not get the pricing? What are you see broadly as those – as you get a second crack at some of them?
Sumit Roy
Yes. It’s largely buyers that rely on the debt capital markets either the CMBS market or the bank loan market. You are in New York, you know what the money market, the big banks, the BofAs, the JPMorgans, the Wells, I’m not going to say that they have a moratorium on new loans, but it is much more difficult for them to create new bank debt or increased revolvers, et cetera, for more distress credit.
So the overall debt market has sort of become a lot more expensive for some of these levered buyers. And that’s what we’ve seen is that they’re no longer being able to honor the original cap rates that transactions were being struck at. And of course, we chose not to pursue those transactions at those given pricing. And so when they do come back to us and as long as we like the transaction, it was just a pricing discussion. We are being able to now, either honor the cap rate that we had or even expand out those cap rates to reflect current market conditions. But the fact that the surety of close has become so much more important for the sellers today is clearly prevalent in a lot of the discussions that we are having with the sellers today.
Nick Joseph
Thank you.
Sumit Roy
Sure.
Operator
The next question is from Connor Siversky with Berenberg. Please go ahead.
Christie Kelly
Hi, Connor.
Connor Siversky
Thanks for having me on the call. I’m curious on this cap rate discussion, and I’m appreciate your comments that you have a correlation between rising rates and subsequent impact on cap rates. But I’m wondering if you’ve ever been able to establish what the lag looks like. For example, with a 25 basis point increase in rates, how long does it take for that to reflect in cap rates? And then second to that, are you seeing that relationship accelerate, given that you are seeing some of these lending partners shut down their operations?
Sumit Roy
Yes, it’s a great question. And unfortunately, if we were in a lab where we could control all variables that sort of drive this correlation, it would be a lot easier of an answer to give you. Historically, when we’ve done these correlations, we have found that the lag to be anywhere between nine to perhaps even as long as 12 months. I was a lot more skeptical coming into this particular situation coming into this year and seeing the rising interest rate environment. Just because of the – the sheer volume of capital that has come into our space on the institutional side. And I was a bit hesitant to continue to say, hey, it’s going to be this nine to 12 month lag before cap rates start to reflect the new environment, because of this wealth of capital.
However, what I didn’t take into account was the debt markets adjusting as quickly as they did. And even this new capital that has come into our space, both on the private equity side, as well as on the public side of the equation. The debt markets adjusted a lot faster. And therefore the pullback from these newer buyers in our space has been a lot more acute, which has resulted in cap rates adjusting a lot faster.
I mean, we’ve had a rising interest rate environment now for the last six months. And we are already starting to see cap rates adjust 25 to 50 basis points. And like I said, in the grocery sector, we saw sale leasebacks being done in the low fours that are now coming back and being done in the low fives to mid fives. So it’s not a constant Connor that I can point to. It is a reflection of the environment that you’re faced with, but it’s a good thing for us truth be told that cap rates can adjust, as quickly as they have in a rising interest rate environment. I just hope that the corollary is not true.
Connor Siversky
Got it. That’s a very interesting color. I’ll leave it there. Thank you.
Sumit Roy
Thanks.
Operator
The next question is from Haendel St. Juste with Mizuho. Please go ahead.
Christie Kelly
Hi, Haendel.
Haendel St. Juste
Hey, there. Hello, everyone. So I guess, I’m curious on your assessment of the non-high grade portion of the market right now. Curious, I understand, it’s not a focus of yours, but you do dabble and do have exposure there. Curious, of the relative attractiveness of high grade versus perhaps non-high grade and if there was a scenario perhaps enough premium of a return to perhaps make you do a bit more on the non-high grade side. Thanks.
Sumit Roy
Hi, Haendel. Yes. This is a narrative that continues to be out there that we are not focused or that we are disproportionately focused on the high grade side of the equation. Just look at what we did this quarter. I mean, 62% of what we did was sub-investment grade or non-rated. So it is – I don’t believe true to say that all we focus on is investment grade credit and that particular product.
What we have tried to share with the market clearly unsuccessfully. So that we focus on risk adjusted returns that are points in time where the risk adjusted returns on investment grade credit is far superior to what we were seeing on the non-investment grade side. And we pivot there and we try to do those transactions. And then there are other times where the exact opposite is true, where sub-investment grade is allowing you to capture risk adjusted returns that are far superior.
And so we find ourselves in that period today, where we are finding very good opportunities on the non-investment grade side of the equation, and as such are being able to get a lot of those transactions over the finish line, i.e., 62% in the second quarter. So we are indifferent to the credit ratings. What we focus on is looking at the totality of that particular opportunity to then ascribe a return profile that makes sense for the risk that we are undertaking. And that will continue to vary. We don’t target investment grade. Investment grade tends to be a byproduct of the underwriting. So hopefully that clarifies the question you asked.
Haendel St. Juste
Sure, sure. Certainly appreciate the color, the perspective. Any update with Encore still on track to close I believe in fourth quarter, how’s the regulatory and licensing coming along.
Sumit Roy
Still on track, we are quite optimistic. We’ve continued to stay very close to the MGC. We are working very closely with them, so we are very optimistic that it’ll close by the end of this year in the fourth quarter.
Haendel St. Juste
Thank you.
Sumit Roy
Sure.
Operator
The next question is from Brad Heffern with RBC Capital Markets. Please go ahead.
Christie Kelly
Hey, Brad.
Brad Heffern
Hey, everyone. Hi, Christie. One for you, I guess. On the new guidance, can you just talk about the moving pieces that kept the AFFO per share number unchanged despite the higher acquisition total? I assume it said potentially tighter spreads versus the cost of capital, but I’m curious if there was a FX impact or a interest expense impact or anything else.
Christie Kelly
Yes. I think, Brad, just to start off Sumit – Sumit had started to touch on this in terms of some of the moving pieces given the fact that we had increase our acquisition volume to over $6 billion, but kept as you observed in our AFFO per share guidance the same and reaffirmed it. And there are some factors there in terms of first, the volatility in the capital markets as we’ve discussed, the overall rate hikes and the magnitude of those hikes and any future actions that may be taken. Both in terms of the European and U.S. environments. We also to the point that you were making. We do actually hedge from the perspective of FX to protect our international income as well as we’ve got hedges in place to lower our effective interest rates, and we’ll touch on that a bit more in a second. But the other thing too is that just the general timing of the investment volume, the team has just been doing a great job. We’ve got really strong momentum as Sumit discussed in the market. And the acquisitions that we close from now towards the end of the year, while our attractive are really going to be setting us up nicely for 2023.
So the timing of that isn’t as beneficial for the year in AFFO as it will be for the full year impact next year. And I think, to the upside, we still have some clients on cash accounting, that have just started under their deferral arrangements. And so we’ll be monitoring them for continued consistent payment performance, and make the appropriate calls and alignment with our policy and guidelines when we may be taking them off of cash accounting. But I’d love to turn it over to Jonathan to talk a little bit more specifically about hedging and the impact.
Jonathan Pong
Thanks, Christie. Yes, Brad, you’ve seen us obviously issue a lot of local currency debt in the sterling market that’s intentional, obviously, much lower haul in rates there. But certainly, from a natural hedge perspective, having interest expense denominated in the same currency where we’re now getting rent limits the exposure that we have in volatility. And then we have a cleanup methodology where we hedge a portion of AFFO that is unhedged. And so from that dynamic, we feel like we’ve mitigated the range of outcomes, upside and downside, but there is still some unhedged exposure, about 60% of our foreign-denominated AFFO is unhedged. So for every 10% move in the dollar, for instance, you’re looking at maybe $0.015 of volatility on an annualized basis. So, we’re not completely hedged, which can lead to upside if we see some mean reversion here in the dollar. But just a little bit of conservatism that we’re taking here sitting here in August.
Brad Heffern
Okay. I appreciate all the color. And then, Sumit, some of your peers this quarter have talked about portfolios trading at a discount to single assets. Is that something that you’ve seen? And are you interested potentially in pursuing more portfolio deals?
Sumit Roy
No more than in the past, Brad. Portfolio deals generally do tend to trade at a discount, especially in times like this when the cost of capital have gone up. And a lot of these potential buyers of big portfolios are sort of sitting on the sidelines. So this is essentially reverted back to where it was, where we would get a discount on portfolio transactions. And so if you look at our volume today, about 62% of what we did were portfolio transactions. So that actually accrues to our benefit, Brad, and we are certainly seeing exactly the same scenario as some of our peers have commented.
Brad Heffern
Okay, thank you.
Sumit Roy
Sure.
Operator
The next question is from Wes Golladay with Baird. Please go ahead.
Wes Golladay
Hi, everyone.
Christie Kelly
Hi, Wes.
Wes Golladay
Hey there. I got a question also maybe on the FX, more so on the future hedging, I guess. As you buy more properties overseas, would you do more, I guess, CP issuance tip for the hedging? And could we see the U.S. issuance of CP maybe go down to zero and unusual full capacity overseas?
Jonathan Pong
Hey, Wes, it’s Jonathan. I’ll take that one. You may have seen our euro commercial paper program establishment recently, $1.5 billion equivalent together with the upsizing of our U.S. dollar commercial paper program. Focusing on the Euro CP side, we absolutely intend to utilize that to the extent that we have a use of euro currency. But right now, obviously, interest rates are much lower comparatively. We could probably issue one year year-old CP [ph] in a 25 basis point context and that compares to revolver borrowings that are 75 basis points or so. So certainly, having a liability and a very cheap liability at that denominated in euros will be additive on all fronts, limiting the amount of derivatives that we have to engage with to hedge our exposure and lowering the old interest rate that we have to pay on your borrowings.
Wes Golladay
Got it. And then want to go back to the comment, sorry, go ahead.
Sumit Roy
Yes, Wes, having said all of that, we will be leaning towards permanently financing our acquisitions as soon as possible. I mean this is really a mechanism for us to provide the surety to the market and take advantage of our A-/A3 rating. But this will continue to not dominate our overall debt profile. If you look at what our outstandings are today, it’s about 7%. And that is how you should think about us running up business going forward.
Wes Golladay
Got it. Then I want to go back to that comment about why do you need cap rates. I’m just curious if you’re seeing any difference between sale leasebacks, marketed assets, developer takeouts, any of your channels that you look at?
Sumit Roy
Yes. It’s not a function of the channel. I would say, Wes, it is much more a function of the overall market. If you are starting to see cap rates move in portfolio transactions, whether the portfolio comes from another seller or from a sale-leaseback avenue it’s going to be reflective of markets. Does relationship play a hand? Sure, it does. But those are 5 basis points to 10 basis points to maybe 15 basis points at best. But it is really the market that dictates what those cap rates are going to be, not so much the channels.
Wes Golladay
Great, thanks a lot.
Sumit Roy
Thank you.
Operator
The next question is from Joshua Dennerlein with Bank of America. Please go ahead.
Christie Kelly
Hi, Josh.
Joshua Dennerlein
Hey Christie, hey, guys. So now that you’ve kind of completed the integration of the VEREIT merger, what – how are you guys thinking about additional M&A?
Sumit Roy
Josh, we won’t let us breathe, will you?
Joshua Dennerlein
You guys go to work hard. I mean, especially Jonathan, he got to work extra hard.
Sumit Roy
That’s true. That’s true. Josh, we’ve always said that, look, as far as M&A is concerned, we are always open for opportunities. But it is not easy to facilitate an M&A trade. You need willing partners, you need the market environment to be conducive, you need to be able to look at the other portfolio to figure out, is there a massive amount of overlap in terms of strategically what we would have gone after had this entire portfolio been available.
You then have to take into consideration social issues. There are so many things that sort of have to align before you can help facilitate an M&A trade. But having said all of that, and this is very consistent with what we’ve said in the past, we are always looking. And if the right opportunity presents itself, we’re not going to shy away from it. So, we’ve shown that we can do it. We’ve done it a couple of times now. And we’ll keep looking and keep working hard, like you said, Josh.
Joshua Dennerlein
And then I think you mentioned grocery anchors. It sounds like the cap rates moved like 100 basis points higher. Were there any other asset classes or property types where you’re seeing that kind of magnitude of a move?
Sumit Roy
Yes. The industrial, I would say, not across the board, but some industrial, the movement has been quite pronounced as well, don’t know if it’s 100 basis points, but it wouldn’t be far to say, 50 basis points to 75 basis points. I just felt like the grocery market decelerated, i.e. the compression of the cap rates was so immediate from where we used to buy grocery here in the U.S., in the high-5s, this was the best-in-class grocery it accelerated down to the low-4s. And this was absolutely a testament to the amount of capital that had come into our space and the cost of debt available that allow these buyers to essentially hit the yield that they required on a cash-on-cash basis.
And the unwinding was as quick, partially driven by what the Fed chose to do, partially driven by how that translated into the debt market. And then the withdrawal of some of this capital that relied on the debt markets. So, I think that phenomena is very unique to that particular sector of retail. And we didn’t see that compression in any other sector that I can think of.
Joshua Dennerlein
Interesting. Thanks guys.
Operator
The next question is from Ronald Kamdem with Morgan Stanley. Please go ahead.
Ronald Kamdem
Hey, just a couple of quick ones staying on, maybe not..
Christie Kelly
Hey, Ronald.
Ronald Kamdem
Hey, how are you? Just staying on the theme of large acquisitions, maybe M&A, but just even just bigger portfolio deals. I remember one of the benefits of sort of having a larger platform is being able to do these larger sale leasebacks, just any update on how that pipeline is building. And when can we see sort of more of those deals come through?
Sumit Roy
Yeah, Ron I’ll tell you the pipelines is big. And we are in discussions on fairly sizable opportunities. Again, similar to my comments with regards to M&A, I think it’s difficult, sellers are still a bit anchored on the past in terms of where the market was literally five to six months ago, and their willingness to sort of recognize the current state of affairs is what’s going to dictate as to whether these conversations and these pipeline opportunities translate to under contract opportunities.
But I can tell you, Ron, that our pipeline has never looked stronger and a lot of that makeup is from bigger portfolio transactions. And so we are hopeful that a few of these will get over the finish line, and if it does, you’ll be the first to know.
Ronald Kamdem
Great. And if I could just ask one quick one on the guidance, just what’s the assumption for – and sorry if you covered this already, what’s the assumption for bad debt and that change at all, because it seems like that’s been pretty low?
Sumit Roy
Yeah. Jonathan or Christie should take that.
Christie Kelly
Yeah. In terms of we’re on a bad debt. Yeah. There was no specific change as it relates to bad debt. And in terms of the impact, for example, we’ve talked a lot about the clients that we still have on cash accounting and the fact that the deferral arrangements for a good approximately handful of those that were primarily impacted during COVID in the theater and health and fitness space. Their deferral arrangements started in July. And so we will be looking at their continued strong collections performance and make the appropriate calls in relation to our policies and things as we continue through this year and determine if we will be taking any of those clients off of cash accounting. And some of that impact Ron, is also one of the variables that we factored in as it relates to the upper end of our guidance.
Ronald Kamdem
Thank you.
Jonathan Pong
Ron, I’ll just add, in terms of the remainder of the year guidance we’re really looking at more of a normalized assumption. So, the first half of the year we’ve actually benefited from some paybacks on deferral agreements that have actually resulted in flat or even negative bad debt expense. So a little bit of conservatism in back half of the year, just given the macro environment and uncertainties. But definitely assuming just a normalized run rate in a pre-pandemic year.
Ronald Kamdem
Thank you.
Operator
The next question is from John Massocca with Ladenburg Thalmann. Please go ahead.
John Massocca
Good afternoon.
Christie Kelly
Hi John.
John Massocca
How’s it going? So as we think about the competitive environment you face in the Europe versus the U.S., I mean, how sensitive are your European competitors to rising rates? And I guess if we can see continued upper pressure on UK and EU rates, could it push certain competitors out of the market kind of similar to what you’ve seen in the U.S. year-to-date?
Sumit Roy
Absolutely. not trying to be flipping to John, but that is exactly what we expect to see happen. I think I mentioned that the BFA has just raised their interest rates by 50 basis points to 1.75%[ph]. We should start to see the cap rates adjust, but a lot of the levered buyers and those happen to be quite a few there. We will start to fall by the wayside. We’ve already seen that on a few transactions that we’ve been pursuing in the international markets. And again, this certainty of close is what gets amplified at times like this.
And we’ve had transactions that literally have come back to us in the international markets, because they recognize our ability to close on especially large transactions. And so I expect, what we are seeing happen here in the U.S., a similar storyline to play out in the international markets and given that the level of competition that we face there, John is actually a lot less. We expect those advantages to be even more enhanced in quarters to come.
John Massocca
And I guess maybe if we think back to kind of 3Q and 4Q of last year, I mean, how important was the non-public levered buyer in the European markets versus the U.S.? Is it kind of a bigger portion of the competitive set or is it equal less?
Sumit Roy
Yeah, that’s very difficult to quantify, but if I had to guess, I would say that there are more of the buyers in Europe that rely on the debt markets. And what makes it challenging is that the debt markets are potentially not quite as mature as we have here in the U.S., the circa few fewer people that we were competing with for the kind of product that we’ve been pursuing. And this is consistent with one of our strategic reasons to expand into Europe is the lack of similar kinds of competition that we see here in the U.S. and more of an amplification of our inherent advantages in that particular market. And we are certainly starting to see that more so recently.
John Massocca
Okay. And I know it’s a relatively recent phenomenon, but as you think about tenant credit, both with acquisitions and the in-place portfolio, how are you thinking about sellers of kind of hard goods versus more services-oriented tenants, given some of the recent shifts in consumer demand?
Sumit Roy
Yeah, it does depend on the type of hard goods. I will tell you, Walmart just came out with another announcement today. They’re getting pressured. But do I see Walmart struggling to pay their rent? I don’t. Do I see now, if you were to look at categories, do I see apparel companies suffering a little bit more, especially if discretionary income continues to get pressured? Absolutely. Do I see quick service restaurants suffering the same? I don’t. We saw this play out in the great financial crisis where some of the service oriented businesses actually thrived.
The movie theater business did very well. The health and fitness business did quite well because, especially the lower cost health and fitness concepts, because they tend to attract the more value sensitive consumer base at times where alternatives have become a lot more expensive. I do expect, casual dining to feel a little bit more of the pressure. But again, the concepts are important who the operator is important, their balance sheet strength, their ability to take lessons learned from the pandemic where there were a lot more click and collects and deliveries that they were able to pivot to in terms of their business model. Those I think will hold them in good stead for the ones that survived and were able to institute those types of changes to their business model. But it’s very much specific to the particular vertical and the environment we find ourselves in.
John Massocca
Very helpful color. That’s it for me. Thank you very much.
Sumit Roy
Thanks, John.
Operator
The next question is from Chris Lucas with Capital One. Please go ahead.
Christie Kelly
Hi there, Chris.
Chris Lucas
Good afternoon. Hi, Christy. Good afternoon, everybody. Just a follow-up question on the commercial paper program. I guess, I’m just thinking about it so you’ve got $1.5 billion denominated in €1.5 billion denominated. Was there a specific reason why euro denominated rather than pound denominated related to efficiency, depth of market future uses? Just trying to understand why euro and not pound?
Christie Kelly
Sure. Chris.
Jonathan Pong
Hey Chris, it’s Jonathan, you know, there’s a nuance in the commercial paper market. The storage market is really not that big. So you don’t really see a lot of stand-alone sterling programs. The Eurocommercial paper program does give us the flexibility to issue in sterling. And so to the extent there is demand in that market, we’ll be able to tap into it. But by and large, this market is dominated by dollars and euros.
Chris Lucas
Okay. Great. Thank you for that. And then Sumit, just kind of taking a step back, sort of talk a little bit around the foreign exchange issue that’s occurred this year. You’ve seen a pretty meaningful move in both in terms of the dollar appreciation relative to the euro and the pound.
And if you kind of look historically back at this other than really like a week during COVID in March of 2020, you have to go all the way back to the Reagan [ph] Administration decline sort of this relative value on both the pound and on the, on the euro impact that far, but in terms of the dollar strength. So my question is, does that impact at all your view about where to allocate capital at this point? Or are you completely agnostic to the exchange rate?
Sumit Roy
It would be unfair to say, Chris, that we are agnostic to the exchange rate. Obviously, this is something that we have an acute focus on – like we said, we are not 100% hedged. That wouldn’t be economically prudent to do so. We are about 40% hedged on our income stream. And we have instituted strategies to sort of mitigate fluctuations in the foreign exchange market.
Having said all of that, we did exactly the same analysis, Chris, to figure out at which point in time where these exchange rates at current levels and concluded the same that look, again, I might look foolish in three months from now.
But this looks like the low point in terms of foreign exchange between the GBP and the U.S. and the euro in the U.S. And you’re starting to see with increases in interest rates by the Bank of England, similar to the ECB, you’re starting to see that correct itself and start to revert a little bit more to the mean.
So that could potentially act as a tailwind. But not knowing and not trying to take a forecast on where these things are going to play out. That’s the reason – one of the main reasons why we kept our range exactly the same, but we believe that we are very well situated currently. Ultimately, this is a long game. And what we want is to let the product and the acquisition opportunities dictate with is with an eye on the exchange rate, dictate how we build out our portfolio. So totally not fair to say we would be agnostic, but it is something we keep in mind, but doesn’t necessarily drive our strategy in its entirety.
Chris Lucas
Great. That’s helpful. That’s all I have this afternoon. Thank you.
Sumit Roy
Thank you, Chris.
Christie Kelly
Thank you, Chris.
Operator
The next question is from Harsh Hemnani with Green Street. Please go ahead.
Christie Kelly
Hi, Harsh.
Harsh Hemnani
Hey, Christie. A quick one for me. When you think about the investments in Europe, what percentage of them are sale-leaseback originations versus acquisitions of existing leases? And how does that compare to your investments in the U.S.?
Sumit Roy
I don’t think that there is a major difference between the compositions. If you look at what we did on the sale leaseback side, Harsh, it was right around 28% year-to-date. And we’ve had quarters where it’s been as high as 75% and we’ve had quarters where it’s been as low as 20%. And so it really is a function of what’s available, when is it closing in a given quarter, et cetera, that dictates the sale-leaseback piece.
Having said that, I think when we do decide to pursue sale leasebacks in a meaningful way. It is possible that some of those transactions would be much larger in size. For instance, if you think about our inaugural transaction that we did when we first went into the U.K., it was a sale-leaseback that we did with Sainsbury’s. That was $0.5 billion.
If you think about the gaming industry and the sale leaseback we’ve done with them, it’s going to dominate that particular quarter because it’s a $1.7 billion transaction. And we see similar types of opportunities where when and if those close in a given quarter, it’s going to dominate that particular quarter. And I don’t think it’s unique just to the U.S. I think it will be consistent between the U.S. and the international markets.
Harsh Hemnani
Okay, thank you.
Sumit Roy
Thank you.
Operator
The next question is from Linda Tsai with Jefferies. Please go ahead.
Linda Tsai
Hi.
Christie Kelly
Hi, Linda.
Linda Tsai
Hi Christie. In terms of the 2% growth in same-store revenue, I saw health and fitness and restaurants and materially theaters contributed to the positive change in second quarter same-store. When did the strong comps start to normalize? And is that partly dependent on cash basis payback?
Sumit Roy
It is. It’s when we start to sort of take a lot of these clients off of the cash basis and get them back on accrual basis. You’re still going to have a period of about 12 months where there’s going to be this mismatch. And some of these higher, same-store rental growth that you’re seeing is essentially a byproduct of moving some of these cash accounts back to accrual account. And once all of this normalizes, you should expect us to be back in that 1% to 1.5% same-store growth.
But right now, it’s a period where we are now starting to recognize and move some of these clients and case in point AMC back to accrual accounting, and that’s disproportionately impacting the growth rate in a very favorable way.
Linda Tsai
That’s helpful. And then I think previously, you talked about putting some money into vacant properties to redevelop to help releasing prospects. Is this something you’re still pursuing?
Sumit Roy
Very much so, Linda. And I think that is being captured in some of our re-leasing spreads that we’ve – that I’m so proud of the asset management team, over 105% essentially net with zero TI dollars. A lot of that – not a lot, but some of it is certainly driven by our repositioning. One of the highest recapture percentages that we had was taking a quick service concept and converting it into an alternative retail concept largely driven by a predictive analytics tool, saying that the best and use for this particular location is not a quick service restaurant, but this alternative concept. And we went down that path and we’re able to recognize north of 200% in terms of recapture rates.
And we share all of that information in aggregation with you on our supplemental so you can track some of that. But that is absolutely very much a focus of ours, Linda, and we hope that, that will continue to be – become a bigger and bigger portion of the value driver of our growth going forward.
Linda Tsai
Thank you.
Sumit Roy
Thank you.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Sumit Roy for any closing remarks.
Sumit Roy
Thank you all for joining us today. I hope everyone enjoys the rest of the summer, and we look forward to speaking with you again soon. Thank you.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
Be the first to comment