Ladies and gentlemen, thank you for standing by, and welcome to the Realty Income Third Quarter 2020 Operating Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would like to now hand the conference over to your speaker today, Andrew Crum, Associate Director of Realty Income. Please go ahead, sir.

Thank you all for joining us today for Realty Income's third quarter 2020 operating results conference call. Discussing our results will be Sumit Roy, President and Chief Executive Officer; and Jonathan Pong, Senior Vice President, Head of Capital Markets and Finance. During this conference call, we will make certain statements that may be considered forward-looking statements under Federal Securities Law. The company's actual future results may differ significantly from the matters discussed in any forward-looking statements. We will disclose in greater detail the factors that may cause such differences in 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'd like to ask additional questions, you may reenter the queue. I will now turn the call over to our CEO, Sumit Roy.

Thanks, Andrew. Welcome, everyone. As we remain in a remote work environment to promote the safety of our employees and community, I continue to be impressed by the resiliency and talent of our team to drive our business forward through the current pandemic. I also remain appreciative of the support and resiliency of our clients and partners, who continue to perform under difficult circumstances. On the personnel front, we were excited to announce that Christie Kelly has been appointed Chief Financial Officer and Treasurer. And we look forward to Christie joining us in January. Christie's depth and breadth of experience with leading real estate companies will be immediately additive to our team. Over the last year she has been a valuable member of our Board of Directors and the Board's Audit Committee, which will further promote a smooth transition. I look forward to partnering with Christie to continue advancing Realty Income's strategy and objectives. Moving on to a summary of the quarter. During the third quarter we invested approximately $659 million in high-quality real estate including $230 million in the UK, which brings us to nearly $1.3 billion invested year-to-date. Investments during the quarter were primarily concentrated in the home improvement, convenience store and grocery store industries, each of which continue to perform well through the current environment. On October 1, we diversified our access and presence in the global capital markets as we closed on our debut public debt issuance of Sterling-denominated notes, raising £400 million in 10-year notes, with an effective annual yield to maturity of 1.71%. We are grateful for the support we received from the UK fixed income investors community, and we look forward to building on these relationships in the years to come. We took steps to further position our balance sheet for growth during the quarter, as we raised approximately $349 million of equity, primarily through our ATM program. Our net debt to adjusted EBITDAR ratio at quarter end was 5.3 times, which is well within our target leverage ratio, and provides significant financial flexibility moving forward. Based on the strength of our investment pipeline and our continued access to well-priced capital, we're increasing 2020 acquisitions guidance to approximately $2 billion. Moving on to investment activity during the quarter. In the third quarter of 2020, we invested approximately $659 million in 89 properties located in 21 states in the United Kingdom, at a weighted average initial cash cap rate of 6.4%, and with a weighted average lease term of 12.7 years. On a total revenue basis, approximately 73% of total acquisitions during the quarter were from investment grade-rated tenants or their subsidiaries. Of the $659 million invested during the quarter, $429 million was invested domestically in 82 properties at a weighted average initial cash cap rate of 5.9% and with a weighted average lease term of 15.4 years. During the quarter, $230 million was invested internationally in seven properties located in the UK, at a weighted average initial cash cap rate of 7.5% and with a weighted average lease term of 8.9 years. Year-to-date, we have invested approximately $1.3 billion in 180 properties located in 28 states and the UK, at a weighted average initial cash cap rate of 6.3% and with a weighted average lease term of 13.1 years. On a revenue basis, 56% of total acquisitions are from investment-grade-rated tenants or their subsidiaries. Of the $1.3 billion invested year-to-date, $845 million was invested domestically in 167 properties, at a weighted average initial cash cap rate of 6.2% and with a weighted average lease term of 14.8 years. Year-to-date, approximately $454 million was invested internationally in 13 properties located in the UK, at a weighted average initial cash cap rate of 6.4% and with a weighted average lease term of 10 years. Transaction flow remains healthy, as we sourced approximately $14.1 billion in the third quarter. Of this amount, $10 billion was domestic opportunities and $4.1 billion were international opportunities. Of the opportunity sourced during the third quarter, 53% were portfolios and 47% or approximately $6.7 billion were one-off assets. Year-to-date, we sourced approximately $46.6 billion in potential transaction opportunities. Of the $659 million in total acquisitions closed in the third quarter, 44% were one-off transactions. Our investment spreads relative to our weighted average cost of capital were healthy during the quarter, averaging approximately 164 basis points for domestic investments, and 328 basis points for international investments. We define investment spreads as initial cash yield less our nominal first year weighted average cost of capital. Our investment pipeline remains robust, and we are well-positioned with strong financial flexibility to capitalize on opportunities going forward, resulting in our increased acquisition guidance. Moving to dispositions, during the quarter we sold 36 properties for net proceeds of $50 million, and we realized an unlevered IRR of 19.7%. This brings us to 65 properties sold year-to-date for $183.6 million at a net cash cap rate of 6.6%. And we realized an unlevered IRR of 13.6%. Our portfolio remains well diversified by tenant, industry, geography and property type, which contributes to the stability of our cash flow. At quarter end, our properties were leased to approximately 600 tenants in 51 separate industries located in 49 states, Puerto Rico and the UK. Approximately 85% of rental revenue is from our traditional retail properties. The largest component outside of retail is industrial properties at over 10% of rental revenue. Walgreens remains our largest tenant at 5.8% of rental revenue. Convenience stores remain our largest industry at 12.1% of rental revenue. Within our overall retail portfolio, approximately 95% of our rent comes from tenants with a service non-discretionary and/or low price point component to their business. We believe these characteristics allow our tenants to operate in a variety of economic environments and to compete more effectively with e-commerce. These factors have been particularly relevant in today's retail climate, where the vast majority of recent U.S. retail bankruptcies have been in industries that do not possess these characteristics. We remain constructive on the credit quality of the portfolio, with approximately half of our annualized rental revenue generated from investment grade-rated tenants. Occupancy based on the number of properties was 98.6%, an increase of 10 basis points versus the prior quarter. During the quarter, we re-leased 80 properties recapturing 99.2% of the expiring rent; year-to-date, we re-leased 238 properties, recapturing 99.8% of the expiring rent. Since our listing in 1994, we have re-leased or sold over 3,400 properties with leases expiring, recapturing over 100% of rent on those properties that were re-leased. Rent collection across our portfolio has remained stable. During the third quarter, we collected 93.1% of contractual rent due, and we collected 92.9% of contractual rent for the month of October. Further improvements in rent collection percentages are primarily dependent on improvements in the theatre industry, which I will touch on shortly. Our collection rates are calculated as the cash rent collected, divided by the contractual rent charged for the applicable period. Charge amounts have not been adjusted for any COVID-19 related rent relief granted and do include contractual base rents from any tenants in bankruptcies. We collected 100% of contractual rent for the third quarter from investment grade-rated tenants, which further validates the importance of a high-quality real estate portfolio leased to large, well-capitalized clients. While we have not historically prioritized investment grade-rated tenants as a primary objective, during periods of economic uncertainty, high-grade credit tenants tend to provide more reliable streams of income as the last three quarters have proven. Our top four industries, convenience stores, drug stores, grocery stores, and dollar stores, each sell essential goods and represent approximately 37% of rental revenue. We have received nearly all of the contractual rent due from tenants in these industries since the pandemic began. Uncollected rent continues to be primarily in the theater and health and fitness industries, as these industries account for approximately 80% of uncollected rents during the third quarter. As we continue to manage our portfolio to support long-term value creation, we believe the breadth and depth of our asset management and real estate operations department, which is our company's largest department, is a key competitive advantage vis-à-vis our competitors. I would also like to update the investment community on our latest views on the theater industry. The industry represents 5.7% of our contractual base rent. We do expect the industry to downsize in the future; however, we continue to believe it will remain a viable industry in a post-pandemic environment, especially for high-budget blockbuster movies. As a reminder, the U.S. Box Office reached an all-time high as recent as 2018, and 2019 produced the highest grossing worldwide film of all time, Avengers: Endgame. Recent reports from China, where over 80% of movie theaters are open, show that daily box office revenue has recovered to 2019 levels. We acknowledge that cultural nuances do influence theater attendance, but it remains a relevant data point. We believe that, particularly for blockbuster movies, a theatrical release will be the preferred distribution channel for studios going forward, given the superior economics afforded to them versus the streaming platform. That said, we recognize that the industry is changing, and there will likely be a rationalization of theatres in a post-pandemic reality. Under this scenario, underperforming theatres may not survive. Near-term, several uncertainties face the industry, particularly around when the major movie studios will feel comfortable releasing their films through the theatrical distribution channel. With theaters in New York City and Los Angeles, the two largest markets in the U.S., remaining shuttered, we, like others who follow the industry, lack clarity as to whether studios will be inclined to release blockbuster films. As a result, our confidence level associated with the collectability of a portion of our outstanding theater receivables has diminished, and the near-term solvency risk facing the two largest operators in the space, AMC and Cineworld, is incrementally more pronounced. To that end, we believe it is prudent to establish a full reserve for the outstanding receivable balance for 37 of our 78 total theater assets, and to move to cash accounting for revenue recognition purposes for these 37 assets going forward. We deemed the collectability of rents for these 37 theater assets to be less than probable, based on a variety of factors, including the store level performance of these assets. To be clear, we believe our theater portfolio is of very high quality, and we estimate that 82% of theatres in our portfolio are in the top two quartiles of each operator's portfolio in terms of store level performance. Specifically, of the 72 theater assets that we have recent unit level financial information on, we estimate that 41 are in the top quartile, 18 are in the second quartile, 11 are in the third quartile, and two are in the bottom quartile based on pre-pandemic EBITDAR performance. Our criteria to determine which of these assets to move to cash accounting was predicated on a holistic approach, based largely on these productivity rankings on a pre-rent and post-rent basis. We determined that 31 of these assets, the majority of which were still profitable based on pre-pandemic financials, generated EBITDA that prevented us from deeming collection as probable. Of the remaining six assets for which we are reserving, we did not have access to unit level financial information to assess collectability. Thus, as a conservative measure, we reserve for those six assets as well. The financial impact of our theater reserves is $17.2 million of reserves recognized for these 37 assets, $1.6 million of which is straight-line rent receivable reserve, and thus has no AFFO impact. The third quarter impact is approximately $0.04 per share diluted to AFFO, and $0.05 per share diluted to FFO. Going forward, we will not accrue revenue on these assets unless we actually collect the cash rent, until we determine collectibility becomes probable again. During the quarter, we recorded provisions for impairment of approximately $105 million, $79 million of which was associated with 12 theater assets. To arrive at the appropriate impairment for our theater assets, we analyzed the same 37 assets where collection probability was deemed less than probable. Of the 37 assets we analyzed, we determined that 12 assets had a probability weighted undiscounted cash flow that was less than the current net book value of the assets. Accordingly, we impaired the carrying value of these 12 assets down to their estimated fair value. As a reminder, provisions for impairment only impact net income and have no impact on the company's FFO or AFFO. Now, I'd like to outline our current thoughts on the long-term outlook for our overall portfolio revenue stream, almost all of which we expect to remain intact in a post-pandemic world. We expect a level of rationalization in the overall theatre industry, which may require repositioning some of our properties. The theatres most likely to be impacted going forward would be a subset of the 37 properties, which we have moved to cash accounting, which in total represent $33.3 million of annual rent or 2% of our annual rent. To be clear, we do not expect to lose the entirety of rent associated with these properties longer-term, even in the event of potential closures. Beyond the theatre industry, we continue to monitor select tenants in the health and fitness and restaurant industries in particular. The overall diversity of credit and real estate quality of our portfolio gives us comfort that any longer-term rent loss would be fairly modest. Moving on, our same-store rental revenue decreased 4.4% during the quarter and 1.5% year-to-date. Our reported same-store growth includes deferred rent and unpaid rent that we have deemed to be collectible over the existing lease term but similarly excludes rent where collectibility is deemed less than probable. The decrease in same-store rental revenue is primarily driven by reserves we recognize in the theatre industry and to a lesser extent the health and fitness industry. I will provide additional detail on our financial results for the quarter starting with the income statement. Our G&A expense as a percentage of rental and other revenue for the quarter was 4.3%. Our year-to-date G&A expense ratio, excluding approximately $3.5 million of severance related to the departure of our former CFO, was 4.5%. We continue to have the lowest G&A ratio in the net lease REIT sector, reflecting our best in class efficiency and the scale benefits afforded us given our size. Our non-reimbursable property expense as a percentage of rental and other revenue was 1.9% for the quarter and 1.5% year-to-date. AFFO per share during the quarter was $0.81, and $2.55 year-to-date. Our AFFO per share for the quarter was negatively impacted by the recording of non-straight line rent reserves of approximately $21.8 million during the quarter, which represented $0.06 per share of dilution. Year-to-date, our AFFO per share was negatively impacted by non-straight line rent reserves of approximately $29.3 million, which represents $0.09 per share of dilution. Briefly, turning to the balance sheet, we have continued to maintain our conservative capital structure and remain one of only a handful of REITs with at least two A ratings. During the quarter, we issued $315 million of notes due 2031 for an effective annual yield to maturity of 2.34%, and subsequent to quarter end, we completed a debut public offering of Sterling-denominated senior unsecured notes for £400 million due 2030, for an effective annual yield to maturity of 1.71%. Additionally, we raised approximately $349 million of equity during the quarter, primarily through our ATM program. Year-to-date, we have raised nearly $2.7 billion of well-priced capital, including approximately $1.22 billion of equity and $1.47 billion of debt. We ended the quarter with low leverage and strong coverage metrics with a net debt to adjusted EBITDAre ratio of 5.3 times or 5.2 times on a pro forma basis, adjusting for the annualized impact of acquisitions and dispositions during the quarter. Our fixed charge coverage ratio remains strong at 5.2 times. We continue to have very minimal net short-term borrowing, as $856 million outstanding on the line and through our CP program was largely offset with approximately $725 million of cash on hand. Looking forward, our overall debt maturity schedule remains in excellent shape, with less than $80 million of debt maturities through year-end 2021, excluding CP borrowings. The weighted average maturity of our bonds is a healthy 8.2 years. In summary, our balance sheet is in great shape, and we continue to have no leverage, strong coverage metrics and ample liquidity. In September, we increased the dividend for the 108th time in our company's history. We have increased our dividend every year since the company's listing in 1994, growing the dividend at a compound average annual rate of approximately 4.5%. We are proud to be one of only three REITs in the S&P 500 dividend aristocrats index for having increased their dividend every year for the last 25 consecutive years. In summary, we are confident in the overall resiliency of our portfolio, and believe our strategy of partnering with large, well-capitalized operators who are leaders in their respective industries will continue to be a successful strategy. The momentum in our investment pipeline, our ample sources of liquidity, and our size and scale position us favorably to capitalize on near-term growth opportunities. At this time, I'd like to open it up for questions.

Your first question comes from the line of Nate Crossett from Berenberg. Your line is now open.

Hey. Good afternoon, guys. Maybe you could just characterize the deal flow heading into the end of the year. Guidance implies a further ramp into 4Q. So, some more color there would be helpful. Where's that weighted in terms of geographies, concepts? Are there any portfolios in there? And then comments on pricing would be helpful?

Sure. There's a bunch of questions in there, Nate. So, I'll try to take it one at a time. Look, I think during the second quarter earnings announcement, I had suggested that the pipeline was building up very strong, and the sourcing data was incredibly high. That momentum has continued in the third quarter based on almost $14.5 billion of sourcing. The good news with regards to this sourcing number is that it is fairly well-distributed across geographies. I would say $10 billion or two-thirds of it was U.S., while one-third is UK. That mix has been fairly consistent throughout the year of the $47 billion odd that we've sourced. Regarding the product that we are pursuing and what the cap rate environment looks like, it is largely in what will be deemed essential retail—grocery stores, home improvement, convenience stores, dollar stores—there continues to be enough product within those sectors, that's keeping us busy. On the grocery side and, to a lesser extent, on the home improvement side, we continue to see both those industries very well represented in the UK. You talked about cap rates or pricing was a specific question. We continue to see pricing cap rates compress, both here in the U.S. as well as in the UK. This is across asset types, both on the industrial single tenant industrial side, as well as the high-quality retail assets that we are targeting and pursuing. Investment grade rated retail today in the U.S. is in the low 5s to potentially even a four handle for certain assets. It rarely gets above a six cap. If you start to look beyond investment grade, yes, you will get in the low 5s to potentially in the low 7s. But there are very few products that we are pursuing with a seven handle in front of it. In the UK, the pricing is even more competitive. Especially on the grocery side, you'll find retail product in the low to sort of 4.2% to 4.3% range, up to the mid-5s. On the single tenant industrial side across both the U.S. and UK, cap rates have compressed, and very good product with tenants we would like to partner with, having long-term leases, are trading in the low 4s. It is a very expensive market, but this is where relationships with previous clients and brokers, and the folks that control some of the transactions, is crucial. We feel very good about the pipeline that we've built. It's part of the reason why we were sitting on some cash to be able to finance right off of our balance sheet.

Okay, that's all very helpful. Thank you. Just quickly, if we go back into a lockdown, and I guess the UK is going into a lockdown this week. What's the impact that you see on the pipeline? Is it different this time around, I guess is the question?

Yes, I'll answer your UK question first, Nate. They are shutting down gyms, movie theaters, casual dining concepts, bars, etc. We have no exposure to those industries, save for one theater in the UK. Most of our exposure is in the grocery side of the business and, more recently, in the home improvement side, both of which are deemed essential retail and will continue to remain open. These are precisely the industries that have experienced tailwinds during this pandemic, due to some social distancing and stay-at-home norms adopted by the consumer base. I feel pretty good about our portfolio and its ability to perform in the event of a prolonged shutdown in the UK. In the U.S., we've also really focused on identifying where the risk lies, primarily in the theater business, and that's the reason why we have spent so much time discussing our thesis and walking you through why we've done what we did on the theater side. Outside of the theater business, the health and fitness aspect is less of an issue; being able to operate at 50% capacity is not an issue in of itself since most of the time at peak capacity levels, they rarely exceed that 50%-55% mark. Given our primary risks within health and fitness industries primarily tied to Lifetime and LA Fitness, they continue to be largely open. In October, we collected 83% of the rent. If we go into a major lockdown, some of the industries that were impacted like casual dining, daycare centers, etc., are now much better equipped to handle a prolonged shutdown than they were in April. We're optimistic regarding their ability to continue utilizing some of the operational methods they've created, like click-and-collect and drive-thru, to manage their business and continue paying rent. The theater industry is where I feel we will see ongoing impacts. Outside of that, we feel positive about the operators in other impacted industries, but they are better prepared this time around than they were in April.

Okay, thank you.

Sure.

Your next question comes from the line of Katy McConnell from Citi. Your line is now open.

Okay, great. Thanks. Can you provide some color on the portion of larger portfolio deals completed this quarter, as far as pricing and tenant credit for those? And any other opportunities like that, that you're looking at today especially in the market construction?

Yes, sure, Katy. Look, 55% of what we closed were portfolio deals in the third quarter. We continue to see a very healthy flow of portfolio transactions. Truth be told, that's what moves the needle for us, especially on the retail side. On cap rates, we have seen portfolios trading at more aggressive cap rates than they were six months ago. We closed on a transaction in the third quarter with a client we have a very good relationship with, and the cap rate we ended up paying on that particular portfolio was 20 basis points inside of where we did the previous sale leaseback with them. Subsequent to that, we've seen cap rates compress even further. We have seen a healthy pipeline of portfolio transactions, and some staggeringly large portfolios are out there in the market. This is a very good situation for a company like ours, where we have the ability to pursue much larger transactions without running into concentration issues, and especially if it's with a relationship client; that has not abated. This is not just a phenomenon we're seeing here in the U.S., we're seeing portfolio transactions in the UK as well. We closed on a portion of a portfolio transaction with one of our very good relationships in the UK in the third quarter as well. The momentum we've generated both in the U.S. and the UK continues to be very strong, and that's what gives us the confidence to have increased our guidance by $500 million at the midpoint of our previous acquisition guidance.

Thanks for the color. And then just a quick follow-up. Could you talk about the progress you've made so far in the held-for-sale assets? And what you're seeing regarding pricing indications? Do you expect a reliance on rent in the industry volume next year to sell down more of your high-risk exposure outside of figures?

Absolutely. We are already up to $186 million, and I think you can expect a similar run rate in Q4, which will be one of the larger disposition strategies we've had in recent years. The commentary on cap rates continues to hold on the disposition side as well. These are assets that no longer fit the profile of our optimal portfolio, but there continues to be a market for them. This is why we were able to achieve such high double-digit, high-teen type unlevered IRRs, because the market is very conducive. We will continue to dispose of assets going forward. It's a story of two baskets; there is definitely a very healthy appetite for the essential retail industries, and cap rates are aggressive in that particular sector. But for assets in health and fitness or theater, there is currently no market. So, we can continue to fine-tune our portfolio towards our optimal mix, but it's a market where you can't just sell any asset you may desire.

Thank you.

Sure.

Your next question comes from the line of Spenser Allaway from Green Street. Your line is now open.

Hey, thank you. This is Harsh, filling in for Spenser. Could you talk a little bit about your disposition activity, just building on that sort of the tenant or industry, or the particular geography that you're looking to exit from, which may not be strategically fitting with your portfolio rate?

Yes. So Harsh, in trying to answer Katy's question, I talked about the volume, but I'll get a bit more specific. The assets we are selling include some grocery assets with operators that we didn't believe fit our long-term profile and we were able to get aggressive pricing. All of the assets sold were here in the U.S. I want to make that point very clear. There were also some convenience store assets sold. These tend to be formats that we wouldn't pursue actively, more like kiosks, 1,500 square feet boxes with potentially tenants that lack the credit profile we desire long-term. The market remains for these types of products, and we're selling those assets. We also sell a lot of vacant assets in this market. Despite the pandemic, there exists an appetite from developers for well-located vacant assets. That's the makeup of some of our sales. Another industry I would throw in there is the restaurant business, as some assets sold occurred there as well.

Thank you. And just talking about theater again. How many of the 37 theaters that forbid collection were deemed less than probable? I have leases that are expiring in the next two years. And then on that, where that would get impaired? Can you provide some more color on them, like the tenants they were leased to or geographies they were in, like within major city centers or something like that?

Sure. We go through the analysis; I think I went through it in detail but I'll be brief. Of the 37 assets, there are two in the top quartile of performance, 16 in the second quartile, 11 in the third quartile, and two in the fourth quartile. Then there were six assets for which we didn't have financial information. That's the 37 assets we deemed conservative—with the potential for rationalization in the theater business, we couldn't say collection probability was high. We moved those to cash accounting. Of those 37 assets, we performed the impairment analysis. Anytime we move to cash accounting, it triggers an impairment. Twelve of those assets were deemed impaired. We ran an analysis comparing undiscounted cash flow to net book value. If it's less than net book value, we take an impairment. That resulted in $79 million of the $105 million of impairment. There was also an office asset resulting in about $18 million of impairment. That constituted most of the $105 million. The lease terms remaining on the theater portfolio is in the high single digits for both Regal and AMC.

That's helpful. Thank you so much.

Thank you.

Your next question comes from the line of Greg McGinniss from Scotiabank. Your line is now open.

Hey Sumit. The average investment size in the UK this year is over $30 million a property versus the $5.5 million in the U.S., which I imagine is just a function of focusing on grocery store acquisitions in the UK. I'm curious, is that the trend we should expect to continue regarding larger average asset size in the UK where universal property types are more limited than in the U.S.?

That's a very good observation, Greg. We have tightly defined parameters for pursuing assets in the UK, which generally fall in one of two buckets: grocery side of the equation or home improvement. Those assets tend to be larger and located in high demographic regions, typically ranging from $30 million to $45 million per asset. Adding to that, we pursue industrial assets, which can sometimes be even larger. That's what drives the price per property points in the UK to be much larger. In the U.S., we pursue many discrete quick service restaurants, etc., which could trade around $1.5 million per property. Consequently, the average property price of $4 million to $5 million reflects the differences.

Thanks. And then shifting gears, thinking about industrial acquisitions, I know you mentioned that cost of capital is an issue regarding execution. There are a couple of peers in the net lease space that appear to be somewhat more successful at closing industrial and manufacturing deals this year, one of which focuses on sale leaseback in the space and another that's trying to make inroads. Are these deals something you've seen and turned down? Or am I somewhat off-base here on this comparison because you prefer a different asset or tenant space? Any new case and coverage on why you may or may not be pursuing or sourcing certain deals would be appreciated.

Sure. I don't want to speak to what our competitors are doing, Greg. However, regarding the assets we're pursuing alongside the operators we work with in the industrial sector, indeed we have encountered mid-6% or high-6% deals, but for several reasons including location or tenant credit profile, we do not feel comfortable proceeding. Thus, we walk away from those transactions. The ones we pursue tend to fall within the pricing zip code I've shared with you. It has been somewhat challenging for us. Thankfully, we've got the cost of capital to pursue some—not all—of these transactions, and we strive to be clinical, leveraging existing relationships. In some instances, the pricing point reaches a level where we feel compelled to walk away.

Okay, that's fair. Thank you.

Sure.

Your next question comes from the line of Brent Dilts from UBS. Your line is now open.

Hey, guys. Thanks for taking the question. So first, could you provide some color on how competition in the transaction market has evolved during the pandemic? I'm specifically looking for maybe how much capital you're seeing come in from outside the industry, such as private equity, pension funds, etc.?

Happy to answer that, Brent. At the very beginning, around June, when we were re-engaging, we were among the few that remained active in acquisitions. We took advantage of that. Some transactions we suspended while entering the pandemic returned to us, and we managed to transact some of them at slightly higher cap rates. However, very quickly, the scenario changed and competitive pressures increased. Even though some of our public peers did not fully engage in acquisitions, there is plenty of capital chasing product on the retail side, which has been the surprise. The industrial space also saw less unexpected compressions in pricing. We've witnessed aggressive pricing trends over the last six months. While there is continuous international money chasing well-located long-term leases, the surprise on the retail side has led to compressed cap rates. It is quite aggressive out there.

Okay, great. And then just sticking with the transaction market, how have bid-ask spreads changed throughout the year? Has there been significant variance by tenant industry?

There were very few transactions taking place during April when everyone was figuring out the pandemic situation. However, once June came around, we began observing a significant influx of transactions that were completed at higher levels than before. Pricing is definitely on the aggressive side with bidding. Thus, we just raised our guidance to approximately $2 billion, which is a testament to the strong pipeline of transactions we already have.

Great. Thanks, Sumit.

Yes.

Your next question comes from Linda Tsai from Jefferies. You may proceed.

Hi, good afternoon. Thanks for the detail on the theatres. When you look at the pre-pandemic profitability for the 41 theatres not on cash accounting, what's your base case for how long the recovery takes to approach those prior levels?

Yes, Linda, that's a great question. I wish I had a definite answer for you. I can share that those 41 assets are all in the top quartile of performance and were generating north of $1 million per asset in EBITDA after rent obligations pre-pandemic. The recovery is dependent on the studios' willingness to release content, and if they continue delaying releases, this could significantly stall earnings recovery. If things go as planned, especially with vaccines and a stronger consumer confidence, we could see rapid recovery. But ultimately, it depends on factors like when studios release films and how comfortable customers feel returning to theaters. We have positive signals like data from China, indicating that they have reached pre-pandemic box office levels despite capacity constraints.

Got it. And so are these better positioned theatres on percentage rents right now?

Most of these assets are structured through sales-leasebacks we previously entered into with Regal and AMC. Thus, they are generally the top-performing assets. As part of repurposing these properties for better ROI, we have established participation in percentage rent arrangements with some of these operators. While I lack a precise count of how many assets are operating on percentage rent, I know that these arrangements were part of our original agreements.

Thank you. And then just one follow-up. In terms of the subset of the 37 assets that would be up for repositioning, what are some alternative uses?

Yes, we continue to be positively surprised. Unsolicited feedback has been shared on one of our theater assets, suggesting it could be repositioned to mixed-use multifamily. Another was identified as a potential last-mile distribution center due to the property size, approximately 12-13 acres. You must go through the zoning processes, but we believe these assets are well-located and can be repositioned effectively. We remain optimistic about how we will emerge from this.

Thank you.

Sure.

Your next question comes from the line of John Massocca from Ladenburg Thalmann. Your line is now open.

Good afternoon.

Hi, John, how are you?

Good. How about yourself?

Good.

Hopefully this doesn't sound like a loaded question. Can you touch on theaters? If an operator went into bankruptcy, would that impact all the theaters leased to that bankrupt tenant? Would those theaters that hadn't been placed in the cash accounting category instantly transition to cash accounting? Essentially, what would be the potential impact on AFFO if something were to happen to Cineworld or AMC?

Yes. If they ceased to exist, there is no doubt. A Chapter 11 filing in itself is not a triggering event; it requires us to assess their future business plans. However, if it switches over to Chapter 7, we must advance to cash accounting immediately on those 41 assets that are not currently on cash accounting. This remains the reason why we keep monitoring AMC. Just yesterday, they sought to raise another $15 million through the ATM program. We continue to ask ourselves how studios are planning to produce high-budget films. They have reduced the number of films produced significantly, and currently 60% of what they do create involves high-budget projects. The core question is whether studios can shift to replicating the theatrical success through alternate distribution channels, something we cannot foresee happening. Time will tell, but yes, if situations change and they proceed along that path, we will need to revisit our assumptions.

Okay. And then touching on Nate's question from way back earlier in the call, and sorry if I missed the responses. How does a lockdown—a second lockdown in the UK—potentially impact deal flow? If at all, I mean 2Q UK deal flow fell to a little over $50 million. Could that happen again? Or was that more a reaction to some financial market uncertainty and overall pricing uncertainty rather than structural problems in closing deals associated with the lockdown?

The product we are pursuing, especially on the grocery side and single-tenant industrial side, should not dry up due to the Prime Minister's shutdown in the UK. As I mentioned, the sectors being affected are not industries we pursue, so that won't impact us. We feel positive regarding our portfolio's performance capability even amidst a prolonged shutdown in the UK. Here in the U.S., we have effectively assessed and mitigated risk mainly in the theater business. We closely monitor the health and fitness sectors, especially concerning Lifetime and LA Fitness, which remain open. One of the reasons we could collect 83% of October rent is due to our strong exposure. If we enter a major lockdown again, operators in casual dining, daycare, etc., have prepared better for a prolonged shutdown than they did in April. To reiterate, unless there's an extensive mandate forcing closure, we are confident in our operators and their ability to pay rent. On the other hand, we do need to consider the possibility of impact on deal flow from Q4 to Q1, particularly if the market reaction wanes. However, our current outlook remains promising.

But is there a potential shift in deal flow from maybe 4Q to 1Q or even 1Q '21 to 2Q '21?

No, actually the 4Q numbers are largely set at this point. The key question would be if some hiccup in the market causes sourcing to die down, which I want to re-emphasize, we see no signs of thus far. But if that were to occur, it would likely affect Q1 and Q2 2021 because you're actively building the portfolio today to close on assets in the first quarter of next year. Fortunately, things appear solid thus far.

Very helpful. Thank you.

Sure.

Your next question comes from the line of Joshua Dennerlein from Bank of America. Your line is now open.

Hey Sumit. Hope you're well. I was curious about your strategy on issuing in the Sterling debt market going forward, and why you chose that market for the linked bond issuance.

How are you, Joshua? It's quite difficult to participate meaningfully in that particular market when we are buying assets there and not match-funding in local currency. For us, it makes perfect sense. We sought to match-fund our first entry into the UK market with Sainsbury's by generating £300 million in local denominated British pounds. Even though we took the 144 path to accomplish that, it was critical to avoid cross-currency hedges which would have led us to leave economy on the table. Given that we have a two A credit rating, we can issue similar tenured paper at 50-60 basis points lower than what we would in the U.S. Our all-in cost was 1.7%. We have assets that have 10-year ship north of 10 years, in fact, on a portfolio basis, it is well north of that. Matching funding with £400 million at 1.71% allows us to create more shareholder value. That was our rationale.

Yes. I would just add. This is Jonathan. This was something we were looking to do very early in the year, and obviously, the pandemic hit. We were patient and waited for pricing to recover to a point where we could execute well inside the pricing of U.S. 10-year paper. Diversification of our investor base on the fixed income side is valuable, and we had a very high-quality order book. This has been a strategic goal of ours since 2019 when we first entered the UK market. It all came together nicely when the time was right.

Awesome. I appreciate that, guys. I'll leave the floor. Thank you.

Thank you, Josh.

This concludes the question-and-answer portion of Realty Income's conference call. I will now turn the call over to Sumit Roy for concluding remarks.

Well, thank you everyone for joining us, and I look forward to seeing many of you at the upcoming NAREIT conference. Thank you very much. Bye-bye.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.