Realty Income’s £429m Sainsbury’s deal is ‘first of many’ UK investments

After 50 years of scaling up in the net lease industry across the US and Puerto Rico, California-based Realty Income Corporation now plans to make waves in the UK and mainland Europe – starting with a £429m deal to buy 12 Sainsbury’s supermarkets. The properties, bought from a joint venture between British Land and Sainsbury’s, will be financed with £300m of unsecured, private placement debt and around £130m of equity. “We are very positive on this being the first of many transactions in the UK as well as mainland Europe,” said Sumit Roy, chief executive of Realty Income. “If this were to be just a one-transaction deal, we would not have gone forward with it.” For Roy, a relative lack of large-scale, pure-play, net lease capital providers in the European market has created the optimal opportunity for expansion. This is compounded by the REIT’s estimate that the potential size of the sale and leaseback market in the UK is more than $1tn (£769bn). “The UK is a natural market for us to incubate our investment activities abroad, given the liquidity of its commercial real estate market and strong underlying real estate fundamentals,” he added. “High population density and limited real estate supply growth creates a compelling opportunity for long-term real estate investment.” For Realty Income this was a transaction in a “defensive, non-discretionary industry that has proven to be resilient throughout economic cycles”. Setting up home in London [caption id="attachment_977550" align="alignright" width="200"] Sumit Roy[/caption] Realty Income now plans to open an office in London, with some employees relocating from the US, where the team will source and finance new deals in Europe. While little is known about the landlord on this side of the Atlantic, it has scaled up impressively in its native US market since it listed on the New York Stock Exchange in 1994. Headquartered in San Diego and founded in 1969, the company owns more than 5,700 properties, with assets leased to 262 commercial occupiers, including Walgreens, 7-Eleven and FedEx. To give a sense of scale, the deal with British Land will mean that Sainsbury’s will become its twelfth-largest tenant, representing 2.2% of revenue. Until the Sainsbury’s transaction, its portfolio operated across 49 states in the US and Puerto Rico. The REIT’s portfolio is heavily weighted towards retail, with 5,623 properties accounting for 81.7% of its rent roll at the end of December. The rest of the portfolio comprises 117 industrial assets, 42 offices and 15 agricultural properties. Perhaps uncommonly for a REIT, it has committed to paying monthly dividends to its shareholders. Although political and economic uncertainty in the UK has broadly slowed investment activity from some international buyers, Realty Income has not been put off by the UK’s unclear future. According to Roy, the UK has shown “long-term macroeconomic stability”, with both its real estate and grocery markets demonstrating a resilience over the past two decades that makes it viable for long-term growth. The strength of the dollar against the pound has also created a compelling investment opportunity, with the current foreign exchange rate approximately 20% below the historic median. And while Brexit presents an “uncomfortable situation”, the ongoing uncertainty surrounding it could generate “additional opportunities” where occupier business models are driven by sales of non-discretionary goods. Roy expects its Sainsbury’s stores to remain resilient “even in the worst-case scenario”. “There will absolutely be some level of impact on the grocery industry, but it will not be disproportionate to Sainsbury’s,” he said. “Its management and CEO have already taken steps to get ahead of this eventuality, from stockpiling hard goods to considering alternative sourcing. Given all of that, we felt the appropriate steps have been taken by Sainsbury’s to get ahead of this.” The deal structure Roy said that some of the leases that were in place on the 12 stores were originally set to expire in four years, with others on terms “a little longer than that” but to fit its criteria for freestanding, single-tenant retail and industrial properties, ideally with net leases of 10 or more years left, Realty has renegotiated the terms to run for 15 years. “We redid the leases to accommodate our need of getting to a 15-year lease term on a net lease basis, with annual rent bumps,” said Roy. “On an occupancy cost basis, they were very much aligned with us and willing to enter into long-term leases but were very focused about our demand for annual rent increases.” He added that it also “kicked out” some underperforming assets that were part of the jv’s portfolio, although he did not disclose how many. While the Competition and Markets Authority’s investigation into the proposed Sainsbury’s-Asda merger continues, the REIT has taken steps to ensure its purchase is insulated from any potential closures. However, as it stands, the merger looks increasingly unlikely to proceed after the competition watchdog highlighted extensive concerns with the deal. “Given the CMA’s [position on the merger] today, it is highly unlikely it will go ahead. But if it were to happen and if there were store closures and divestitures, we will be protected,” Roy said. “We spoke with Sainsbury’s about on this particular scenario; it is really up to them to come up with a solution on the assets in the event they are asked to divest them. “Based on everything we are reading and our conversations with the management team, it does not seem like the Asda transaction will go through. That could change; we will know a lot more towards the end of April.” Now that the REIT has set out its stall to become a major sale-and-leaseback capital provider in the UK and Europe, all eyes will be on where it next plans to deploy its considerable firepower. While pricing in the UK industrial market remains unfavourable for newcomers, the landlord is most likely to stick to what it knows best when it comes to new territories, which is retail. Roy said: “We believe the addressable market in the UK and mainland Europe is extensive. There is a significant opportunity to become a sale-leaseback capital provider to owner-operators seeking to unlock the value of real estate they hold on their balance sheets. Over time, we expect to leverage the competitive advantages of size, scale and cost of capital to grow our portfolio in Europe.” Realty Income Corporation at a glance (*) Founded: 1969 Properties: More than 5,700 Occupancy: 98.6% Tenants: 262 Investment in new properties during 2018: $1.8bn Acquisition volume in 2018: $1.8bn Average annual domestic investment volume since 2013: $1.6bn Net income per share: $1.26 Criteria for lease terms: Ideally 10+ years Realty Income Corporation’s Sainsbury’s portfolio Banbury, Oxfordshire Bodmin, Cornwall Bradford, Yorkshire Bridgwater, South West Cardiff, Wales Grimsby, Yorkshire Hereford, West Midlands Kempston, Bedfordshire Locksbottom, London Northampton, East Midlands Sheffield, Yorkshire -Southampton, Hampshire The Sainsbury’s portfolio in numbers Size: 1.1m sq ft Estimated EBITDAR/rent ratio: >3x Estimated sales per gross sq ft: £550 To send feedback, e-mail pui-guan.man@egi.co.uk or tweet @PuiGuanM or @estatesgazette