Realty Income Corp (O) 2008 Q1 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by, and welcome to the Realty Income first-quarter 2008 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded Thursday, May 1, 2008.

I would now like to turn the call over to Tom Lewis, CEO of Realty Income. Please go ahead, sir.

Thank you, Michael. Good afternoon, everyone, and welcome to the call. Our purpose is to review the first-quarter operations and give you some color for the balance of the year.

With me in the room today is Gary Malino, our President and Chief Operating Officer; Paul Meurer, our Executive Vice President and Chief Financial Officer; and Mike Pfeiffer, our Executive Vice President and General Counsel; and Tere Miller, Vice President of Corporate Communications.

And as always, I'm obligated to say that during this conference call, we will make certain statements that may be considered to be forward-looking statements under federal securities law. The Company's actual future results may differ significantly from the matters discussed in the forward-looking statements, and we will disclose in greater detail in the Company's quarterly 10-Q the factors that may cause such differences.

As we always do, we will have Paul start and kind of do an overview of the numbers. Paul?

Thanks, Tom. As usual, I'm going to comment on the financial statement and provide a few highlights of our results for the first quarter, and start with the income statement. Total revenue increased 17% for the first quarter as compared to the first quarter of 2007.

Rental revenue increased to just under $82 million in the quarter, primarily as a result of new property acquisitions. On an annualized basis, our current total rental revenues are now approximately $330 million. Same-store rental revenue increased 1.5% for the quarterly period, and other income was approximately $1.5 million for the quarter.

On the expense side, interest expense increased by about $11 million during the quarter as compared to the first quarter of last year, and this of course was due to more bonds outstanding as compared to a year ago, specifically the $550 million of 2019 notes that we issued last September.

We had zero borrowings on our credit facility throughout the first quarter. And on a related note, our interest coverage ratio continues to be strong at 3.2 times, while our fixed charge coverage ratio was 2.6 times. These numbers are a little bit lower than usual due to the interest expense on the excess cash from our September bond offering.

Depreciation and amortization expense increased by almost $4.9 million in the comparative quarterly period, as depreciation expense has increased as our portfolio continues to grow.

General and administrative, or G&A, expenses for the first quarter were about $5.5 million, representing only 6.6% of total revenues for the quarter, and we continue to expect G&A expenses in 2008 to remain at or below 2007 levels.

Property expenses increased on a comparative basis to just over $1.2 million for the quarter. These expenses are primarily associated with the taxes, maintenance and insurance expenses which we are responsible for on properties available for lease.

Income taxes consist of income taxes paid to various states by the Company. These taxes totaled $398,000 for the quarterly period.

Income from discontinued operations for the quarter was a negative $28,000. Real estate acquired for resale refers to the operations of Crest Net Lease, our subsidiary that acquires and resells properties. Crest sold 15 properties for $17.5 million during the quarter for a gain on sale of $2.7 million. However, Crest also recorded an impairment totaling almost $2.4 million on two properties. Overall for the quarter, Crest contributed income of negative $269,000.

Real estate held for investment refers to property sales by Realty Income from our existing core portfolio. We sold one property and some excess land during the first quarter, resulting overall in income of $241,000.

Preferred stock cash dividends remained at about $6.1 million for the quarter. Net income available to common stockholders was $23.7 million, down from $30.3 million in the first quarter of 2007.

Funds from operations, or FFO, decreased 1.3% to just under $46 million in the quarterly period. FFO per share remained flat at $0.46 per share. All of this FFO, however, came from our core portfolio, which was an increase from $0.45 from the core portfolio a year ago.

When we file the 10-Q we will again provide information you need to compute our adjusted funds from operations, or AFFO, or actual cash available for distribution as dividends. Our AFFO, or cash available for distribution, is typically higher than our FFO as our capital expenditures are relatively low and we don't have a lot of straight-line rent, and that was true again for this quarter.

Our continued growth in core earnings allowed us to continue increasing our monthly dividend this quarter. In March, we increased the dividend for the 42nd consecutive quarter and the 48th increase of the dividend overall since we went public over 13 years ago. Our current monthly dividend is now $0.137375 per share, which equates to a current annualized amount of $1.6485 per share.

Briefly turning to the balance sheet, we've continued to maintain a conservative capital structure. Our debt to total market cap was 33%, and our preferred stock outstanding represents about 8% of our capital structure.

We have zero borrowings on our $300 million credit facility, as I mentioned, and thus no exposure to variable-rate debt. Our credit facility also has a $100 million expansion accordion feature. As we mentioned in the press release, we're currently in discussions with our bank group regarding the possible recasting of a new longer-term facility, though of course we do have the ability to simply exercise the one-year extension option this coming November. Furthermore, our balance sheet at March 31 notes over $13 million in cash available.

In November 2008, we have $100 million of bonds coming due, and in January 2009 we have another $20 million of bonds coming due. As we said on the call last quarter, we plan to reserve cash or credit facility capacity for this $120 million of obligations over the next 12 months. Thereafter, our next debt maturity isn't until 2013. So we do not need to access any new capital for any upcoming fixed financing obligations.

In summary, we currently have excellent liquidity, and our overall balance sheet remains healthy and safe.

Now let me turn the call back over to Tom, who will give you more background.

Thanks, Paul, and I will run through the different areas of the business.

Let me start with the portfolio. As you can see in the release, we ended the quarter at 97.4% occupancy and 61 properties available for lease out of 2375 that we own in the portfolio. That is off about 50 basis points from the last quarter. 15 of the new vacancies came from credit default from a couple of tenants. That's not a significantly large number, given that we have almost 2400 properties, but it's an increase nevertheless.

I think everybody is aware of the Buffets filing involving 116 of the properties that we own. That today comprises about 6.7% of our rents. We are in the middle right now of working on that and negotiating, and it will continue to unfold. We believe we will be able to give everybody pretty much a full report probably on the second-quarter conference call, perhaps on the third, but hopefully the second. And then we can report I think with a lot of clarity as to exactly what happened, where the revenue stream ends up, what we got back and where we see it being leased.

I think overall, relative to Buffets, their business continues to be challenged by the economic headwinds. And while we believe that we own profitable properties with Buffets, I think it's safe to say the margin of safety that we had has been eroded somewhat, but we continue to believe the vast majority are profitable. That will probably impact what we thought we would be receiving from Buffets somewhat, but we've built that into the guidance which you see here, and that is not the total reason for the change.

We will have some brief commentary in the Q that will disclose that. They have rejected 14 of our properties. I think most of you have made note of that. 12 are from our core portfolio, two that we will hold in Crest, and I will talk about that a bit later. And outside of that, they are current with their rent through April on the balance of the properties we own. And as I mentioned on those 12, we've built that into our guidance.

Again, the negotiation is going on with Buffets, so I don't want to say too much publicly at this time which might hamper our ability to do what we want to relative to that negotiation. I'll also mention that the court has given them an extension from May 21, which was the initial date from which they had to make all their decisions relative to the real estate, to August 19.

That 90-day extension is part of the law and not unusual for that to have happened. But since we're working with them at this point, I would anticipate that perhaps we can get through what we're going to do before that date comes and then obviously be able to report back on a pretty straightforward basis as to what happened. And again, we've captured what we think will happen in our guidance.

Same-store rent on the portfolio during the quarter increased a nice 1.5% versus 1.2% for the fourth quarter, so up about 30 basis points. Of the 30 different industries we have in the portfolio, one had declining same-store rents, four had flat same-store rents, and 25 saw some type of same-store rent increases. About half of the increases came from just a few industries, with the majority of that coming, strangely enough in this environment, from restaurants, and then the balance from childcare, auto service and convenience stores.

We continue to diversify the portfolio. We're up, as I mentioned, to 2375 properties, 30 industries, 119 retail chains in 49 states. And during the quarter, we added another 106 properties with eight different retailers.

As to industry exposure, restaurants are the largest industry. It's at 23.7%, down from 24.2% for the fourth quarter. And as we said in our year-end call, we are full in that industry segment and have stepped back, and you'll now see that number begin to fall as we add in another areas and also do a few sales in that area, not a large amount, but a few.

Convenience stores are next at about 14.3%. That's down pretty continually over the last three, four years. Then after that, theaters were about 8.8%, down from about 10% a year or two ago.

Childcare is down to 7.7%. For those of you that have watched the Company for a long time, that's down substantially over recent years. And we continue to be mindful of diversification in the portfolio.

At the end of the quarter, our largest tenant is 6.7% of rent, the next largest is 5.3%, and then it goes down from there. I think if you take the 10 largest tenants for us, that's about 41% of revenue, and our 15 largest today are 54% of revenue. That's down from 55% last quarter.

By the way, when you get to the 15th-largest tenant, you're only talking about 2.2% of revenue, and when you get past the 20th tenant you're talking about 1.3% of revenue, so it declines fairly quickly from there. So we remained fairly well diversified.

The average remaining lease length on the portfolio also remains healthy. It's currently at 13.2 years, and that's been kept up, as you probably noticed, from the acquisitions this quarter having some longer lease terms and also from leasing some of the properties that are undergoing lease rollover at the end of their initial terms into longer leases.

As I mentioned, the top 15 tenants are about 54% of revenue. Our best credit metric for kind of keeping tabs on them is obviously the cash flow coverage of rent, of EBITDA at the store level individually. And at the end of the quarter, the average cash flow coverage for our 15 largest tenants on a store basis, and that's EBITDAR coverage, was about 2.7 times exactly, ranging from 1.7 to 4.55 times versus the first quarter; it was 2.76 there and ranged 1.88 to 4.19. So that's 2.7 times still. And we think, given the economic environment and what's going on in retail, the portfolio is actually doing okay.

Let me move on to property acquisitions. We were very active in the first quarter and invested a little over $180 million in 106 new properties. The cap rate was 8.7%, up slightly from what we saw in the fourth quarter. And as I mentioned a second ago, the average lease term was up to 20.6 years.

There were eight different retailers in seven different industries, and the properties were located in 14 different states, so pretty well diversified. All that was for the core portfolio and none for Crest Net Lease, which I will talk about in a bit.

We funded the $181 million by cash on hand that was generated from our September issuance of $550 million 12-year notes. So the cost of the capital there was about 6.77%, and we'll enjoy about 193 basis point spread on those new acquisitions, which obviously is accretive right away and should grow as time goes on.

Relative to overall the acquisitions environment and what we see out there, we will continue, by the way, to use $250 million for now in guidance for acquisitions. But with $181 million in the first quarter, we should have no problem hitting that number for the year. But I do not want to increase it this quarter at this time.

We continue to see a number of opportunities during the quarter in committee in underwriting. We worked on about $1.5 billion of transactions. From that, we bought the $181 million. And if you pencil that out, that's about 12% of what we underwrote. By the way, for the last five, six years we've averaged about 15% hit rate on those things we underwrite, with a range of 8% to 26%. So 12% is pretty much right down the middle in terms of what we end up buying versus what we underwrite.

Relative to the overall environment and how we see things for the balance of the year, if you look at the market today, I think on the demand side, for net leased properties, the number of 1031 buyers that are looking for transactions I think is declining. As the volume of sales really in other types of properties is also declining, there are less of those people trying to do 1031 tax-deferred exchanges. So that brings back the volume on that side.

I think there are less large people out looking to buy portfolios. I think the people who were flipping, a lot of them have exited the market. I think other institutional institutions that we were competing against have exited the market, and then some are on the sidelines kind of waiting for cap rates to move higher. And then there's still a couple, three people out there that are fairly active on the acquisition side. And there still are buyers out there, but volume is down a bit, and on the buy side there are some buyers out there.

On the supply side, I think obviously a lot of the net lease transactions generated in the last few years were from M&A, a lot from private equity, and that's obviously declined. I think that's brought down overall volume. However, there are also sellers out there, and we continue to see transactions in the marketplace.

I also think, like other sectors, the real estate market, the bid/ask spread between buyers and sellers is pretty large right now, and unless owners are really compelled to do a transaction, they are trying to hold out for lower cap rates. And I think the buyers are out there recognizing cap rates are moving and may move further and want cap rates to move up. So, generally, cap rates are heading higher, and we continue to see that pressure on the transactions that we look at.

Relative to where the market is, it's kind of all over, particularly when you have a lower amount of transactions. But generally, I think on larger transactions, they are creeping into the high 8s and perhaps the low 9 cap rates, seem to be moving up a bit.

And for the one-off transaction out there, if you're trying to buy, it's a really interesting market because it's really bifurcated. If there's a really good brand or tenants on the lease, if it's a low price point, say $1 million to $2 million, so getting financing from your local bank is not an issue, or -- and it's in a good market, a good SMSA, then I think you're still looking in the low 7s for cap rates on the sale of those one-off properties, and we're seeing that in our operations.

However, at the same time, if it's a secondary or tertiary brand, if the price point moves much about $2.5 million, $3 million, or if it's not in a major market, I think you've really seen cap rates move, and that can be up into the 8s or even into the 9s off one-offs. So I think it's a lot like what you see in the debt markets today, where credit spreads have widened substantially, and it's the same thing in the net lease business. It has to do with who the tenant is and their quality, if the price point is low or high, and then what market it is in. And I think that will continue for a few months.

It's kind of typical when cap rates are moving up for transaction volume to slow a bit. And I think that will continue until either people who have real estate need to do transactions because they can't do financings in other parts of the capital markets, either that or if cap rates stabilize, then I think you would see the market open up. It's our view, I think, looking out over the next six to nine months that there are a lot of people with real estate on the books who currently don't have good access to other forms of capital. They are going to have capital needs that are coming upon them, and we think, probably over the next few quarters and into 2009, if the capital markets don't come back very, very strong, which I'm not sure they will, they will probably need to come to market with their product, and that will likely move cap rates up further and close that bid/ask spread and I think lead to some opportunities if you are out there and can buy.

Either way, we think being patient right now relative to the volume makes sense and will likely pay off in higher cap rates down the road. So for now, we're going to stick with the $250 million number that we've been using, subject to change, depending on cap rates and market conditions.

I will also note, it's nice to have capital should we see any compelling opportunities. As we said in the release, we've got $13 million of cash on hand, no balance on the credit line of $300 million. We've got about $30 million of free cash flow coming out this year and then about $50 million in sales between what we see in Crest and out of the core portfolio. So we continue to be pretty liquid in this environment.

Let me move on to Crest Net Lease for a moment. As most of the people on the call know, Crest is our subsidiary that acquires and then immediately sells net lease properties. We started this company about eight years ago. Generally, it's been a good performer for us and is used primarily to allow us to buy large portfolios and then remain diversified by immediately selling off some of the properties.

As we always say, and I think on every call since we've started it, though, it does make money, but unlike our core revenue from long-term leases, its contribution is primarily on property sales, which means it is transaction based and it ebbs and flows pretty heavily quarter to quarter and year to year.

For anybody that has just been covering us for a year or two, I will give you some background on Crest. If you look back the last six years or so, in '02 Crest made about $0.04; '03, $0.06; '04, $0.10; and then $0.03 in '05, $0.02 in '06, and then we earned $0.11 a share in Crest in 2007, which was really a peak earnings year. The $0.11 was a function of having started with a lot of inventory at the beginning of the first quarter of 2007 and then obviously because of that having a lot of sales last year.

We started the year last year with 60 properties in inventory, about $138 million of inventory. Most of it was added in the fourth quarter of '06. We bought another $30 million in the third quarter of '07, so about $168 million of total inventory that we added in. And we've been pretty much paring that inventory down through sales over the last year.

We did not buy anything in Crest in the fourth quarter and we did not buy anything in Crest in the first quarter of '08, and we plan no acquisitions in the second quarter here in '08 for Crest.

Current inventory at the end of the quarter was just $31.7 million. It's comprised of only 14 properties. We have had a couple of more sales since then. We have another six properties under contract, which really leaves us only six properties available for sale. And we would like to reduce inventory to zero in Crest by the end of the second quarter or early in the third quarter and then let Crest stand inactive for the time being unless the market changes.

It's been very helpful for us in buying large portfolios, as I mentioned, and selling off the concentration. But what we found really in the fourth quarter and again here in the first quarter is with a lot of net lease buyers gone from the market, we've been able to structure our transactions without using Crest, taking some of the properties out while we're doing the transaction, and anticipate that will be the case for awhile, given there are fewer buyers. But we do not have to use it and we can buy portfolios without doing that.

I also think with cap rates moving up that this type of business carries substantially more risk than it has over the last few years as cap rates decline. If you really look, since 2002 through 2007, when we were using Crest, we were very much in a declining cap rate environment, and it makes that business look very easy and very profitable. And as I made note of, we believe that that environment is different today and we are in a rising market.

As we also noted in the press release, we impaired two properties in Crest the tune of about $0.02 per share this quarter. These were two properties leased to Buffets that were rejected and that I mentioned earlier and went dark. And we went through the appropriate accounting, since these assets are held for sale, to analyze the vacant value and a conservative estimate of what they would be leased at and try and get an absolute conservative current valuation methodology and mark those to market, which we did, and that was the $0.02.

Overall, we are very pleased to have little left for sale in Crest here, and quite frankly, since it's been a small add-on to the business used primarily for acquisitions, which we don't need it for today, we're happy to be winding that down.

Let me move on to dividends. As Paul mentioned, we increased the dividend the last 42 quarters. I would anticipate we would look to continue to raise the dividend here in 2008 on a regular basis. And I'm optimistic that that will continue for quite a while. And we continue to believe dividends will increase.

Relative to FFO, as Paul mentioned, it was $0.46 in the first quarter versus $0.46 for the same period of a year ago. Crest Net Lease had no FFO for the quarter, based on the impairment I just discussed that offset about $0.02 in gains in FFO from sales that we otherwise would have had.

FFO before Crest's contribution, or core FFO, was up $0.01 to $0.46 from $0.45 a year ago or up about 2.2%. Obviously, absent the impaired impairment, we would have done $0.48 a share or up 4%, which is not what we did, due to the impairment.

Let me move on to guidance for a minute. We've made a change, obviously, in the guidance here to $1.84 to $1.90 per share, or down about $0.10 per share from what we were previously estimating, and that's really a function of reducing Crest to an estimated $0.01 to $0.02 in FFO this year. That accounts for about $0.05 per share of the adjustment we made, and it does include the impairment we just took.

We took out another $0.04 for additional anticipated vacancies. Buffets was a little bit of that over and above what we had before, but it's also a number of other properties with other tenants we expect will happen over the balance of the year, and given our view, we wanted to build that in. And then there's $0.01 in costs associated with replacing our credit facility with a new one. We are working on that as we speak and will comment further on that probably in the form of a release if and when we complete the process.

We think the $1.84 to $1.90 is our best estimate of what will actually happen at this point. It is an estimate, and I don't believe it's reaching, nor are we lowballing anything. And I would tell you it would not surprise me at all to hit the low end of the range. However, I believe we could also hit the middle or the high end of the range, depending on what happens.

That overall would make 2008 about a flat year for FFO growth. Our core portfolio, we anticipate, of operations will grow at about 2.2% to 6% this year. And that will be offset by the reduction in Crest that I talked about as we make it inactive.

Let me talk a little bit just kind of generally about what we're trying to do here. As we sit back today and kind of look at the results from the retailers, talk to retailers and watch what a lot of you are watching relative to the economy and consumers and the retailers, we really see that it's a challenging environment out there going forward and may become more challenging for the retailers and the consumers.

At the same time, we also think that we're going to be in a period where cap rates are going to be rising. And given that that's our view, the question is kind of, okay, what moves do you want to make? What should we be doing different today from what we were doing six months ago, when that view was a bit more moderate? And what we've tried to do is identify where we think the primary risks are in the business and either eliminate that risk or assume that more of that risk that we see will actually exhibit itself, and try and capture those in the numbers.

And for us, that's really vacancy. We increased our assumption for credit default here. What we did is we went and looked through the portfolio, and we assumed there would be additional stress on each of the retailers we do business with for the balance of the year. That included a bit more, as I mentioned, for the Buffets reorganization. We then went through and did a complete review of our top 20 tenants, trying to estimate, really, what was out there. And that captures a lot of the rent. And as I mentioned earlier, by the way, when you get to number 21, that's like 1.3% of rent. And in the top 20, the only one we made a change on was Buffets, and we do not anticipate at this time vacancy from others that are in the top 20.

We then, though, took a look at those below our top 20 tenants, where we have fairly small exposures, and did some assumptions for additional vacancy for a smattering of tenants that we have small positions in. We took a few more cents for that that we think will exhibit itself this year, and that is what we assume will happen, actually, not that it might.

Most of that, and I think this is a really key point for those of us who have -- all of us who have been looking at the Company without a lot of credit default for a long time as we've really been supported by low interest rates and a consumer that's out there spending more than he makes -- and that is, most of the lost rent is from the time it takes to retenant the property, which will fall mostly in 2008, and then we will recover a fair amount of it in 2009.

When you have a default, initially in the vacancy, obviously, you receive no rent when you get the property back. And as well, you have to pay the property taxes, maintenance and insurance. And that hits you right away until the property is released in the year when you have that vacancy. And that's here in 2008.

Then in the following year, when you go ahead and lease that property, obviously the expenses are again being paid by a tenant, and you recapture a fair amount of the hit you took that year. And that's kind of the differential we see here in '08, where whatever vacancy there is hits, and then there's recapture of it going into 2009. And I think that's kind of key.

And it was really going through that review of the tenants, adding in a little more for Buffets, and then generally assuming one more fact, which is interesting. Normally, when something goes as vacant, we anticipate that it will probably be vacant about six months. And we use that in our planning relative to rental loss and also expenses. And we thought, given where the economy is, it may be a little more difficult to release. And so in our assumptions, we've adjusted that to nine months, which also has an impact. But anyway, of the $0.10 reduction, that's really where $0.04 comes from and how we're looking at it.

I think the primary area of risk in the short term for the portfolio, we believe, really was Crest, which obviously makes money on transactional income by buying and selling. I mentioned that it's been helpful for us. I also mentioned competition has abated quite a bit, and we really don't have to use it, and haven't, over the last two quarters.

But with Crest, we really think the risks are twofold. First, in an increasing cap rate environment, really your inventory gets marked down continually. And if you bought it thinking I'm going to sell this thing at a 100-basis-point spread, when cap rates are moving up, what can happen is your 100 can become 90, then 80, then 40 and eventually go negative. So you end up losing some money rather than making it.

That really brings up the second risk, which is impairment. Since the properties in this type of business are held for sale, this is a marked-to-market business. And if the cap rate you sell at goes above the cap rate you bought at, you must immediately impair the property and continue to do so each quarter if cap rates continue to rise. And we think, obviously, if cap rates do rise the way we think they might, there's an enhanced risk of that today.

The second risk there is what we saw this quarter, which is if you did a default or a vacancy, then you must immediately impair the property and look at its current value for sale if it is vacant, and that also can take a hit.

So we really think, given that, given that we see higher caps taking Crest to inactive status until either we get a recovering economy or we get a stable cap rate environment, probably makes sense. And then still, we would probably only use it if we felt it would help us buy larger portfolios and not just to add on some incremental transaction volume and FFO.

And again, thankfully, we've got the volume down substantially to only about $31 million, and we'll continue to reduce that and see if we can get it to zero either by the end of the second quarter or shortly thereafter. And that is about $0.05, as I mentioned, of the reduction in guidance.

And then the next one, obviously, is looking at the credit facility. It's up in the fall. We also have a one-year option to extend that is up to us. And so we have a fair amount of time on that line. However, really looking at the credit environment, we think it's prudent to not assume that things will be great 12 months down the road, and see if we can't extend that and work on it a bit, and that's something that we're doing. And again, we will report on that. Were we to be successful with that, we think there's about $0.01 a share there, and those three make up the $0.10 per share in guidance.

Now, the fourth thing we're doing, and it really relates back to seeing cap rates rising or feeling that they are going to further than they have, is to moderate our acquisition activity for a quarter or so here. This has no impact at all to guidance. We've used $250 million in our guidance, with $181 million done in the first quarter. So, obviously, we think we will hit that.

I think for those of us that's followed us a few years, we would usually be increasing that guidance at this time of the year. As you'll recall, we used $250 million as our initial guidance in both '06 and '07, and ended up doing $700 million and $500 million. However, this year, we're going to step back over the next quarter and reduce our activity and watch the market.

Given we think cap rates are rising and might go up a bit further, I think buying a lot in the next quarter that we may be able to buy cheaper in the fall probably doesn't make sense. And so obviously, if it's something that's a 9 cap now, if we think it could be a 9.5 later in the year then it's probably prudent to step back and do that.

Obviously, if things stabilize in the cap rate environment or something really compelling comes along, we can move fairly quickly, given the liquidity. But I think it's a good time to sit back and watch a bit, and that's what we intend to do.

I did mention earlier I think there are a number of sellers who will need to come to market probably in the fall and into '09 if the credit markets don't open up. So I am actually a little bit optimistic about what that could mean for cap rates and also for volumes, but really just not at this time, and we would like to see cap rates move a bit. That will have no impact, by the way, to our guidance, again, since we're working off $250 million.

Anyway, we think that based on that, then, going inactive in Crest, assuming a bit more vacancy, working on the line and moderating acquisition probably makes sense, given the economy. And the net effect overall, if you look at total FFO versus '07, is to go from $0.11 in Crest to $0.02. That's about a 5% reduction in FFO there on a year-over-year. It's a onetime nonrecurring, and wash that out of the system, have the core grow at 2% to 6%, and I think that gets you to kind of flat to slightly down FFO for the year.

I think it also, though, which is really what we're trying to do, leaves us really conservatively positioned, very liquid, I don't think with a lot of market risk. And if the economy picks up or cap rates stabilize, we can move fairly quickly.

Part of this whole discussion around here was one that we similarly had last August, when we were doing the bond offering. And you'll recall that we had a need for a little over $200 million in capital, and when we did the bond offering took $550 million. At the time we did that, we knew, given what we saw as the acquisition pace going forward, there was probably about -- having that money rattling around here would probably cost us about $0.02 a share in the fourth quarter, which it did, and a $0.01 here in the first quarter, which it did, but given we felt rates would rise, probably made sense.

And I think if we had not done that offering, given acquisition activity, we would probably be out in the market doing it today. And I think, conservatively, it would cost us well over 100 basis points more if we did that today, or at 100 basis points on that amount of money, that's $0.055 a share kind of annually for the next 12 years, and that's about $66 million.

So we're trying to say, is there something we can do today that really positions us in what we think is a tough, challenging market credit-wise, consumer-wise, cap rate-wise, and be smart about what we're doing? And that's what I think we're trying to do.

Anyway, if we do that, then for 2009 I think we've got Crest washed out of the numbers. We will release much of the vacancy, and with only modest acquisitions are probably set up, then, for a good year, but probably flat this year.

Anyway, that's what we were thinking. To summarize, then, I think the portfolio is in good shape. Obviously, acquisitions were good for a start, but we're going to slow it. Balance sheet's great, got good liquidity. Core operations continue to grow, and we see the dividend rising. And it will be an interesting year for all of us to watch what transpires.

I apologize for going on a bit long, but as you know, this was an interesting release and I thought I should give some additional color this quarter.

At this point, Michael, if you can come back in, we will take some questions.

(Operator Instructions). Jeff Donnelly, Wachovia.

Thanks, Tom, for the additional color there. A question, actually, concerning the pursuit of the line. I guess I'm kind of curious, what's the motivation here? Is it the extension? Is it the cost of the line? Are you looking to increase your capacity? I guess how are you kind of balancing those as you make your decision?

I think really it's taking a look and saying the most important thing is continued long-term access to capital, and that's probably more important than price. So it is really recasting the line for additional term, even if it costs a bit more or we're doing it a bit early here. I just think it's a smart move in this environment. If you are wrong, it costs you a couple cents, and if you're right then it will be one of the cheapest things you've done.

And then I know you touched on some of these things in your remarks, but I'm curious, what specifically moved you to put Crest on hold and I guess wind that down now versus, say, three to six months ago? I'm not trying to second-guess your decision; I mean, hindsight is always 20/20. But the market's beginning to get a little more volatile, and I think people were talking about rising cap rates in mid-2007. And I guess, why not the decision back then?

You know, it's interesting. We really added inventory heavily at the end of the fourth quarter of '06 and coming into '07. Quite frankly, we had some discussions here. At that point, you could see the cost to insure residential mortgages jumped from 24 basis points to 36 to 360 basis points to 1100, and that was really the first time you saw some stress in the credit markets.

And we did talk about it and went down and said, hey, look, I would like to get the majority of the inventory out under contract or have a lot of clarity by June of last year. And so we really didn't buy anything, really, in the first and second quarter, and we were moving down that way.

In the third quarter, we happened along two particular transactions where we did need to use Crest. Fortunately, in both of those they were relatively good brand names, well known. The properties were in good SMSAs and the price points were $500,000 to $1.5 million, so we gulped and put the other $30 million into Crest in the third quarter, thinking they would sell quickly.

Fortunately, that inventory has really moved fast, and so it was back again in the fourth quarter after that, saying let's not use it. And we really did want to reduce it, but we made a tactical decision there.

Quite frankly, as we move towards the end of the year here, I wanted nothing in Crest then. And I think the other thing that you kind of think through when you've got this type of business, a lot of the things that are easy to sell the fastest. And so it kind of makes the headline look of sales and profits and everything look real good in that flip business. And a lot of what gets left in the inventory are your rougher-type properties. So we also wanted to move ahead pretty aggressively with those. And I think it's all worked out for us. But quite frankly, I would've liked to be out a little earlier, Jeff.

And let's just say you are successful in winding down the inventory by the end of the second quarter. I'm just curious -- I know Crest is not exactly a particularly large entity, at least when it comes to personnel headcount. But what happens there? I guess the gentleman and whoever else works there that is Crest Net Lease, do they sort of stay on staff and Crest runs a very small loss? How does that look, I guess, in the second half of the year?

Well, since Cary is probably listening in -- no, you know what, as you know from coming by, Crest really has only two people that work full time there, and one of them is kind of a leased employee from Realty Income. So there's only one, and that's the person who does the works selling the properties. And he has been one of our acquisition officers. He's very savvy on a real estate basis.

And at the same time that that's happening, we're obviously doing more work on the portfolio and doing some sales. So his skills can be very easily used there, as well as the additional administrative support we use in the activity going on. So it's really just a couple of people and not a major allocation. Expense is fairly small, and obviously moves with the transaction volume. So it has very little impact.

There is also a mortgage we took back, and I think the interest from that mortgage alone will keep Crest profitable and at very little expense. So I don't think there's a lot to be done there. Any of you that follow us, come by the office some time and we will walk you by there, and it will take about a second and a half to walk by Crest's offices.

And just one last question is, I know you kind of went through the reasons for the $0.10 a share reduction, but I guess drilling into the $0.04 specific to the core portfolio, can you tell me how much of that $0.04 was specific to -- I guess I'm trying to parse it out -- how much of it was specific to Ryan's closings that have already happened, maybe closings that you might anticipate from Ryan's, and then beyond that how much of the $0.04 is just from events that haven't transpired that you are assuming will happen?

Sure. I can tell you that of what's closed to date, all of that was in our first-quarter numbers, and none of this $0.04 is that. So that is a little bit of Buffets, but we think there will be some additional, and I'd prefer not to parse it out exactly, because obviously if we are in negotiations there, that provides a lot of information. The balance, though, I would say, was probably 50% stuff that really is happening real-time right now in the second quarter, and the other half what we anticipate will happen the balance of the year.

That's helpful. Thank you.

Philip Martin, Cantor Fitzgerald.

A couple things here. First of all, how conservative have you gone here with this? I mean, obviously from your commentary, Tom, you've scrubbed through this pretty thoroughly and considered a lot of factors. Do you think you have conserved enough at this point, knowing what you know?

You know, it's interesting. I tried to mention this is what I think will happen. I haven't tried to say, hey, as long as we're going to knock the number down here, let's take an extra nickel or something so we look good later. It's literally it will not surprise me at all to be at the bottom end of that, and I think middle and upper can also happen there, too.

Obviously, what's changed for us over the last 30 days is, I mentioned to Jeff, I had a view relative to Crest. But we kind of feel stronger about that, but it's really watching the last 90 days out in the economy. And I think you can see it really throughout the portfolio. You look in convenience stores, which are actually pretty healthy, but you start seeing $0.02, $0.03 come off the gas margin. You start seeing a 3.5% or so or drop in sales in the stores, where a lot of the profits are made. And you can tell it's that consumer on a marginal basis.

And you can look through restaurants and see prices -- see the consumer still eating out, but migrating from the $18 ticket to the $16 ticket to the $12 ticket. And really, just it's really more intense. I can say that we see it a lot more here and think it's happening than it was 90 days ago. So that is probably it.

But we think that number that we're putting out there is what will be achieved. I wouldn't get too excited above that unless acquisitions really open up or some big deal comes along. And my sense is it would be late enough in the year where the FFO isn't really going to hit a lot this year. It would probably be next.

What percentage of your portfolio would fall under the 1.5 times EBITDA coverage?

I would make it EBITDAR and include rent. But I'm not sure I can really answer that. That top 15 number, kind of the bottom guy is 1.7, and the other ones on up. I think if you get into the ones behind that, they have similar coverages, but maybe a little bit less.

So there is that out there, Philip. And what we did is went through the tenants to say anybody that's close to the line relative to their leverage and see some decelerating operations, which properties have lower coverage, let's -- [those would] go. But even though there are some at the 1.5s, if the tenant is very strong they can probably take a fair amount of stress before anything happened. So it's out there, but there's not a huge amount of the 1.5 and below.

The tenants where you -- in the anticipated or expected vacancies, where were their coverages? Kind of all over? I know coverage and tenant-specific, they don't necessarily go hand in hand.

Philip, this is Paul. Between 1 and 2, so meaning profitable, certainly profitable, making money. But balance sheet, operational issues, and as we've said before, even with something, say, 1.25, once they get into -- let's say they go into a bankruptcy situation. They may still walk from a property of that nature that's even slightly profitable as part of their overall strategy. They may pull out of certain states to make their G&A more simplistic or their strategy better.

So if we look at all those kind of factors, too, with each of those tenants and said even if it's profitable, they may pull out of it, that means downtime, that means property expenses, but it also means actually we can release the things. And so it's more of an '08-type impact.

In terms of just replacement value, at least it's nice to think that if you have to go through one of these situations, a weaker economy, where there's stress on tenants, that you're pretty well protected from an asset value standpoint. When you look across your portfolio and you compare where you own that, on a gross basis, versus replacement value, can you give us some indication of (technical difficulty)

(technical difficulty) back to replacement costs. So when you get into these situations, I'm not sure replacement cost is a focus number. But when you are acquiring, it's just one of those good anchor of value price points you try and thrown there to make sure you're not getting too far away from reality.

Okay, exactly. It's a backstop.

Right.

My last question, and you touched on it in your commentary, but in terms of -- now, I know there's several reasons for delaying some growth here, and I think the main one is to just be patient and let things ride out and to potentially wait for better pricing, better transactions, etc. But how much of this is really that you don't want to increase Crest's exposure? I know you mentioned that the deals that are out there, you are possibly able to cherry-pick a little bit more. But how much of delaying some of your growth here is really related to not wanting to put really anything in Crest and have that exposure?

None whatsoever. In the last two quarters, I can tell you that there really haven't been transactions we've passed on because we didn't want to use Crest. In each case, we have been able to talk to the people and rework the portfolio and get some out and buy. So I don't think there's any at all.

What it is is I mentioned cap rates moving, and that's one reason. And then the second reason is, it's kind of funny -- one week we are all in a huge credit crisis, and the next week everybody feels so much better. But I'd just as soon leave the balance sheet where it is right now, with no balance on the credit line and some cash sitting around and knowing I've got free cash flow coming in.

In the long-term view, which is how we try and manage the business, a quarter doesn't matter all that damn much. But if you get into a real tough credit environment, I think not only will you be so happy you do that, it's far worth the quarter you kind of laid back a bit. And then secondarily, it will leave you in position; then if there's some stratification between those that have balance sheets and those that don't, you might have some opportunities. So it's really just a call for that, and we will clearly say we might be wrong with it, but that's what we're going to do.

No, it sounds like a good plan, at least in my opinion. Okay, thank you very much.

Michael Bilerman, Citi.

This is Ambika with Michael. Could you go through the anticipated releasing cost of releasing this vacant space and what kind of timeframe you're assuming -- I think you said six to nine months -- and how we should think about historically what it's been and what you are anticipating in the future?

I would use nine months. I wouldn't use six. Now, some will be done in three and then some will take much longer. But I would lay it right on that. Relative to increased expenses this year, Paul, in our guidance?

Yes, it's really the taxes, maintenance, insurance, the additional let's call that carrying costs that you eat during that timeframe before you release the property. It's a little bit of a double hit, right? You have no rent for a bit. Then you recover close to all of it or some of it, or most of it, in most cases. But in the meantime, you're also paying the property expenses.

So this year, we estimate property expenses at around $5.5 million. You're seeing that already start to present itself in the first quarter. Property expense number, for the most part, it's going to be a little bit larger than that run rate if you multiply that by 4. That compares to about $3.5 million in 2007. So that's about $0.02 a share, and that's part of the $0.04 that we're looking at. So when we talk about a little bit of a loss from vacancy issues in the portfolio, it's not just about downtime with rent. Some of it is related to the property expenses.

Okay, great. And then if we're thinking about AFFO, how should we think about the CapEx associated with refitting the space for a new tenant?

You know, we really don't foresee a lot more of CapEx on that. That's a very good question. For everyone's benefit out there, CapEx for us has typically been a very minimal issue for us. In 2007 it was about $1.8 million, 2006 less than $1 million, 2005 $1.5 million, 2004 $1 million, etc. So it's kind of been in that $1 million, $1.5 million range.

We have estimated already CapEx a little bit larger than that. But that was for some strategic ideas we had for putting some more money in properties to release them. As it relates to these specific new vacancies, as it relates to, say, bankruptcies and that sort of thing, a few more dollars, but that's not a big issue for us. In addition, we have small straight-line rent. It's never been a big part of our rental income stream.

And so our AFFO on a quarterly basis has typically been $0.01 or more higher than our FFO. And we absolutely expect that to be the case. It was in the first quarter, and we expect that to be the case as the year progresses. So I think AFFO this year could be as much as $0.04 or more higher, and actually as much as $0.06, perhaps, if you choose to add impairments back when you compute AFFO. And I know a lot of analysts do that differently.

Okay, that makes sense. And then I guess what gets you comfortable with the fact that the CapEx will be low? Are you far along in your discussions for retenanting these assets?

Well, I think, and I will let Tom augment this, but I think, to give the example for Ryan's, we obviously not too long ago did inspections on those properties, gosh, a year and a half to two years ago, if you will, and we found them to be not only in good locations, but in excellent shape -- in some cases, excellent shape from a physical standpoint, and that that really hasn't been the issue relative to operations or what have you.

So we don't see a lot of dollars. When we actually do an acquisition up front, we certainly look for deferred maintenance items, negotiate those issues up front, either have those repairs made or make sure there's dollars set aside for that. And that purchase, to use that example, was so recent that it's not like there's a whole bunch of maintenance or CapEx issues that we have identified right away.

As you go through the -- when we scrubbed it and we did our list of vacancies, either there has been with one tenant a major renovation effort not long before they started running into problems, and the other ones, the assets are relatively new. So, unlike lease rollover, where you might expect it at the end of 20 years, these assets were in very good shape. So that's not a big component of it.

Great, thank you.

Chris Lucas, Robert W. Baird.

Just one quick question, which is the pace of acquisition for the first quarter, was it early, mid-, late quarter? How would I think about that?

I think we thought it would be early, and then it became mid-, and then it became late, just like all quarters. It seems like all these darn things end up closing towards the end of the quarter every quarter.

Okay, so I should think about it more as a quarter-end kind of event?

That's kind of how we look at it. And it's just funny, because as you get into doing a deal, everybody kind of sits around. Even if they are private and it's a seller, they still report quarterly numbers to somebody, and somehow getting it done by the end of the quarter is what happens.

It's funny, Chris. As you look at the yields that a lot of those deals were done at, the 8.7, you should think of that as early-quarter metric, because this was kind of a yield agreement that we came to with the tenant late last year. But the transaction itself, as Tom said, as is typical for whatever reason, tends to be loaded towards the end of the quarter, and that's where the volume came in in terms of where you'd plug it into your model. But in terms of where you think cap rates kind of are, think of that 8.7 as more of a January cap rate, not a March cap rate, if that makes any sense.

Yes. I guess just a quick follow-up. You mentioned the AFFO adjustments. When is the Q going to be out, Paul?

It will be out this afternoon.

Super. And then my last question -- are you guys seeing any development opportunities come back to you because of poor local sponsorship and the inability to sort of finance the developments through the pipeline or through the completion?

You know, we are hearing of some. I've got a phone call to return right after this on an opportunity. But to be perfectly frank, we do not want to do much in the way of development opportunities. We've cut that down quite a bit over time, and I think it's really a function of finding, over and over and over again, absent a couple of tenants that are extraordinarily strong, that when you're doing development we don't know what the EBITDAR is on that unit until it stabilizes two years later. And that way, we can end up with some of the ones that don't work out. We'd just as soon buy them existing where we can see that stabilized cash flow coverage up front.

[Michael O'Royne, Sun Capital Advisors].

Actually, my question has been answered. Thank you.

Stephanie Krewson, Janney Montgomery Scott.

Somewhat related to Ambika's questions earlier, just looking at the Buffets restaurants, being a Delaware native I may be one of the only sell-side analysts that's actually ever been in one. But they're kind of specific boxes. How fungible do you anticipate those boxes being, or could you just give some further detail on your thoughts as to who would retenant that space?

It's going to be a restaurant. And I think one of the issues there that we have come back with, and I think maybe it's one of those in the underwriting that I don't know that we missed -- I know that it came up in discussion, but I probably focused more on this time -- those are 10,000-square-foot units. They are very big lots. That's great. However, a lot of the users are in the 6000- to 8000-square-foot range. So you're probably going to get some of the people where your rent is a bit lower.

With that said, a lot of them, close to half, were either Lowe's or Wal-Mart type outpads. So I think there's a variety of people that would want to do them. But I think you may see some local restaurants. I think you may see some smaller chains. In some cases, we may end up with somebody that has one restaurant, wants to open a second, sees this as an opportunity, and we may not want it in the portfolio but we would encourage that guy to get an SBA loan or something along those lines and try and sell it to him. And a lot of those guys are owner-users. So I think it's just generic restaurants, and it's generally going to be the 6000- to 8000-square-foot type user.

Philip Martin.

One last quick question. Would you envision any scenario where you may sell some of the Buffets where the leases have been affirmed, etc.?

I think that's one of the things you can always consider. But that's obviously a post-reorganization. One thing, and this is not specific to Buffets when you through this, it's not a lot of fun and you don't want it. However, coming out the other side, generally the balance sheet is significantly in better shape than it was before, and you have that opportunity.

Okay. So from the location standpoint, you are pretty comfortable with these locations and the re-leasing and retenanting, if it comes to that, with more of the properties?

Yes. With the ones that are affirmed and coming out the other side, I'm very comfortable they can be sold. In terms of the re-leasing and retenanting, it's just not a lot of fun, but it's something we do for a living.

At this time, there are no further questions. I would like to turn it back over to management for closing remarks.

Great. Listen, I apologize for the length of the call late in the day. I really appreciate the time and appreciate the attention on what was an interesting quarter. Thanks a lot.

Thank you, sir. Ladies and gentlemen, this does conclude our conference today. You may now disconnect. Thank you for using ACT Teleconferencing.