Realty Income Corp (O) 2008 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen.

Thank you so much for standing by, and welcome to the Realty Income fourth quarter earnings conference call.

During today's presentation, all parties will be in a listen-only mode.

Following the presentation, the conference will be open for questions.

(Operator Instructions).

As a reminder, the conference is being recorded today on Thursday, the 12th of February, 2009.

I will now turn the conference over to Mr.

Tom Lewis, CEO of Realty Income.

Please go ahead, sir.

Thank you very much, Michael, and good afternoon, everyone.

Thanks for joining us for our review of operations and results for the fourth quarter and 2008 overall.

In the room with me today is Paul Meurer, our Executive Vice President and Chief Financial Officer; Gary Malino, our President and Chief Operating Officer; Mike Pfeiffer, our Executive Vice President and General Counsel.

And as always, 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 results may differ significantly from the matters discussed in any forward-looking statements, and we'll disclose in greater deal on the Company's quarterly and on Form 10-K the factors that may cause such differences.

Fascinating.

Anyway, as we normally do, we'll have Paul start with a review of the numbers, and then we'll come back and try and give you some color for what went on in the fourth quarter.

Paul?

Thanks, Tom.

As usual, let me comment on the financial statements and provide some highlights of those financial results for the quarter, and starting with the income statement.

Total revenue increased 3.2% for the quarter and 12.2% for the year.

Rental revenue for the quarter was approximately $82.6 million or an annualized run rate now of about $331 million.

Same-store rental revenue increased only 0.4% for the quarterly period.

However, excluding Buffets, same-store rent growth was healthier at 1.5% for the quarter.

Other income was only $83,000 for the quarter.

On the expense side, interest expense remained flat for the quarter at around $22.7 million.

We had 0 borrowings on our credit facility throughout the entire year of 2008.

On a related note, our interest coverage ratio finished the year strong at 3.2 times, while our fixed charge coverage ratio was 2.6 times.

Our coverage ratios will likely be even stronger in 2009 because of the recent retirement of the $120 million of bonds, which we paid off in the past few months.

Depreciation and amortization expense increased by just under $2 million in the comparative quarterly period, as depreciation expense naturally has increased as the portfolio has grown over time.

General and administrative expenses, or G&A expenses, for the fourth quarter were under $5.1 million, a reduction of over $400,000 from last year.

For the year, G&A was down about $1.1 million.

G&A represented only 6.1% of total revenues for the quarter and 6.5% for the year.

We expect G&A expenses in 2009 to remain at only about 6.5% to 7% maximum of total revenues.

Property expenses increased by $855,000 for the quarter and by $2.3 million for the year.

These expenses are primarily associated with the taxes, maintenance, and insurance expenses, which we are responsible for on properties available for lease.

We expect property expenses to increase again a little bit in 2009, and our current estimate for 2009 is about $6.3 million.

Income taxes consist of income taxes paid to various states by the Company.

These taxes totaled $307,000 for the quarterly period.

Income from discontinued operations for the quarter was $4.3 million.

Real estate acquired for resale refers to the operations of Crest Net Lease, our subsidiary that acquires and resales properties.

Crest, however, did not acquire or sell any properties in the fourth quarter.

Real estate held for investment refers to property sales by Realty Income from our existing core portfolio.

We sold seven properties during the fourth quarter, resulting overall in income of $4.3 million.

And a reminder once again, these property sale gains are not included in our funds from operations.

Preferred stock cash dividends remained at $6.1 million for the quarter, and net income available to common stockholders was $28.3 million for the quarter.

Funds from operations, or FFO, was approximately $47 million for the quarter.

FFO per share was $0.46 per share for the quarter and $1.83 for the year.

FFO before Crest contribution or the FFO from our core portfolio actually increased in 2008 by 2.2% to $1.82 from $1.78 in 2007.

When we file our 10-K, we'll again provide information you need to compute adjusted funds from operations, or AFFO, or the actual cash available for distribution as dividends.

Our AFFO or cash available for distribution is typically higher than our FFO, and it was once again, in 2008, as our capital expenditures remain relatively low and we don't have a lot of straight-line rent in the portfolio.

Our continued growth in core earnings allowed us to increase our monthly dividend again this quarter.

We have increased the dividend 45 consecutive quarters and 52 times overall since we went public over 14 years ago.

Our current monthly dividend is now [$0.14175] per share, which equates to a current annualized amount of [$1.701] per share.

Now let's turn to the balance sheet for a moment.

We have continued to enhance our conservative and very safe capital structure.

Our debt to total market cap is 33% and our preferred stock outstanding represents just 8% of our capital structure.

All of these liabilities are, of course, fixed rate obligations.

We continue to have 0 borrowings on our $355 million credit facility, and this facility also has $100 million accordion expansion feature.

The initial term of this facility runs until May 2011, plus two one-year extension options thereafter.

As of 12/31, we had $46.8 million of cash on hand.

We retired the $100 million of bonds, which matured in November, and the $20 million of bonds that matured last month, in January.

So now our next debt maturity isn't until 2013.

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

We have no exposure to variable-rate debt, and we have no need to raise capital for any balance sheet maturities over the next four years.

Let me turn the call back over to Tom, who will give you more background on these results.

Thanks, Paul.

I'll start with the portfolio.

Obviously, it's doing pretty well today, especially given the state of the world.

I'd like, before I go through the numbers, to say what that said, obviously retail is a tough place today and all of our tenants operate in the same economy that everybody else does.

And certainly it's challenging for some of them.

We've worked with a few of them to get through this period, but to date, to be frank, we've dodged a lot of bullets relative to the filings that you've seen out there with retailers.

And in the few cases where we've had tenants that have had to file, we either have had just a property or two or three, or we've owned their more profitable properties.

And so, to date, we haven't had a meaningful impact on our occupancy or on the operations.

In all of our calls over the years, I think we've talked a lot about owning the more profitable properties or profitable stores of our tenants, and that a high cash flow coverage of the rent we're paid at store-level is certainly our kind of margin of safety, if an industry or a tenant goes through a period where their revenues are dropping or their margins are impacted.

And I think that is just especially true today.

Our 15 largest tenants today account for about 53.5% of our revenue.

And if you look at the average cash flow coverage -- I know that we do this every quarter, for those of you who listen in on a regular basis -- and last quarter, you'll recall at the end of the third quarter, the cash flow coverage at store level for the top 15 averaged 2.79 times, and ranged from about 1.7 to 4.55 times, which was very, very healthy.

Obviously, a lot happened in the fourth quarter in all areas of retail, as we all know.

And we've been getting updated numbers from the tenants for year-end.

And while they lag a little, I think we're pretty current with most of them.

And at the end of the fourth quarter, the average cash flow coverage for the top 15 was 2.4 times and ranged from 1.22 to 3.75; so, obviously very healthy still.

However, you can see some erosion in that and that isn't surprising at all, but the coverages are also doing pretty well.

I think that's the reason the portfolios held up pretty well, and we had a pretty good margin of safety.

We ended the fourth quarter at 97% occupancy; 70 properties available for lease, out of the 2,348.

That's up 10 basis points from last quarter, which is great.

It's a function primarily, I think, of some really effective leasing activity from the people in our portfolio management department.

We're a little bit lucky here in that we built a fairly active portfolio management department to do our leasing in the last nine years, which is a little unusual sometimes at a net lease company.

But given the age of our organization, we've now had, in the last seven, eight, nine years, over 900 properties where the leases have come to the end of the initial 15 to 20-year lease.

And so we built that staff over the years, really, primarily, to handle lease rollover.

And obviously, if you get some vacancy today, it's very, very helpful to have that staff up and operating to deal with any vacancy.

And I think it's served us pretty well.

So, at 97% at the end of the quarter, it continues to reflect pretty good operations.

Same-store rents, as Paul mentioned, on the corporate portfolio were up 0.4% in the fourth quarter; 1.1% for the year.

That growth in same-store rent is lower than in recent quarters.

And I think that will be the case over the next year or so.

It does include the reductions from the Buffet properties we renegotiated last year; but at this point, given the economy and kind of how things look, I'm going to assume that really same-store rent growth will be muted this year.

However, with that said, I like the fact that it's same-store rent growth that is muted, rather than the opposite.

It is kind of instructive to see where the same-store rent declines and increases came over the year.

We have 30 retail industries in the portfolio; 5 had declining same-store rents.

The largest and the vast majority of the declines came where you would expect it, which is in restaurants.

And when you consider that just under half of our exposure -- restaurants are about 20% of the portfolio -- is in fast food, which actually is doing very well, you can see in the casual dining segment and kind of the upper end segment, where we have very little, that that's where the declines would come from.

The other four that were down were barely down at all.

Two of our industries have flat same-store rents.

And then there were 23 that had same-store rent increases, but there was some real concentrations where it came from.

Childcare accounted for about 27% of all of the increases; convenience store, 24%; and then auto tire and automotive service were about 20%.

The rest of the rest of them were very small.

And obviously, I think that's reflective of what's working out there in retail today, which is kind of basic goods and services that you buy on an ongoing basis that have low price points, and that just seems to be the segment that's -- I don't know if it's growing, but it's held up much better than the other more consumer discretionary or durable goods type of retail.

If you look at the portfolio today, about two-thirds of our revenue comes from those type of operators and those type -- I mean, that'd be childcare, C-stores, kind of fast food, anything from auto parts, tire, collision, which tends to be pretty stable throughout a period like this.

And then if you add in some grocery and drug and theater and health and fitness, I think that's the reason that most of those people revenues are holding up pretty good in this environment.

We continue to be pretty well-diversified.

As I mentioned earlier, there are 2,348 properties in the portfolio.

We have 30 different industries and 119 different chains in the portfolio.

And we're pretty well spread out throughout the country in 49 states -- Hawaii being the only place that we're not to date.

From an industry standpoint, fairly well-diversified.

Restaurants is our largest industry; I mentioned it's at 20.8% at the end of the quarter, which is down from 24.2% the same quarter a year ago.

And as we've said for the last few quarters, we'll [full] there and we'll be reducing that back below 20% over the next several quarters.

Convenience stores, 16.4%.

And as we look through the different other categories that we're in, it really goes down from there with theaters and childcare -- theaters is about 9.1%; childcare about 7.5%.

So, pretty good from an industry standpoint.

At year-end, our two largest tenants were only about 6% of rent; the next one is 5%.

It goes down very quickly from there.

And the top 10 comprise about 42% of rent; top 15 about 53% of rent.

And when you get down to the 15 largest tenant, you're looking at -- they're only about 2% of revenue.

Average remaining lease term in the portfolio, which is very nice today, is about 11.9 years.

And that's kept up there pretty well, really based on acquisitions over the last few years and releasing anything that came up under a lease rollover.

Overall, then, with the portfolio, I have to tell you that, given what we saw in the fourth quarter in retail, and notwithstanding that a lot of what we own is kind of basic human needs/low price point, we're pretty pleased that the portfolio held up and we're at 97% and have some same-store rent growth.

Relative to property acquisitions, we've continued to remain inactive, pretty much ever since last February.

During the fourth quarter, you saw in the press release there was some very small addition in acquisitions, but as it has been in the last few quarters, those are primarily just some additional expenditures on some properties that we were developing.

And most of those, I think we started in the fourth quarter of last year, first quarter of this year; and except for maybe a couple hundred thousand, we're pretty much through with any development that the Company had going on and out of that area.

For the year, then, that gave us $189 million in acquisitions; 108 properties; average cap rate was 8.7% with an average lease length of about 20 years.

And I think that's within a $1 million or so of what we guessed last quarter.

And again, we've intentionally been not buying any property or kind of staying out of the acquisition market.

We have believed for some time that obviously cap rates are rising, and anything we could buy would probably be cheaper later.

And given that, why not wait.

And I think that that has served us pretty well.

As we speak and we kind of watch transaction flow out there, and there's not a lot of transactions being completed; however, there are transactions being introduced into the market.

And cap rates are rising, and we're seeing a few people trying to come to market with transactions.

And while they've adjusted cap rates up, I think not really enough.

And so, I think that most of those transactions, or a lot of them, will probably just stall until you see a pretty good move up in cap rates.

We continue to believe there are a lot of people out there with real estate on their books that may have limited access to other forms of financing today.

So at some point, we think we'll see cap rates move up further and more transactions will look attractive out in the marketplace.

And we'll wait until that happens, whenever in the heck that is.

The other issue in acquisitions today, I'll just bring up, obviously, is cost of capital in the market today, I think for us and most anybody.

And as you look at acquisitions and where cap rates are, I could probably go out and do things in the mid-9's today and approaching 10.

But obviously, if you look at your sources of capital, you have your credit line, and that's not permanent capital, so I don't think it makes sense to price it over your credit line.

And the REITs today, even if you're looking at BBB investment-grade senior unsecured, those have traded up over the other BBB's kind of out there in the marketplace, and you're probably looking at 12% plus.

The preferred market has been heavily impacted by the financial institutions coming to market with a lot of paper in the fall and over the summer.

So that market would be up beyond substantially the senior unsecured and really not attractive capital.

So, I really think if you're going to look today at acquisitions and you're going to look at permanent financing, you have to be looking at your common.

And if you took our Company, for instance, and used $20 a share as a round number and kind of mid-rated guidance -- mid-ranged at $1.86, you'd be looking at about a 9.3% FFO yield.

If you grossed that up for offering costs, you're probably up around 9.8.

And since, in the net lease business, you really want to make sure you're securing a substantial spread upfront when you buy, I think you'd have to be looking up at the 11% cap range today before it makes sense to go out and be buying anything, and have an adequate spread over your cost of capital --notwithstanding that you'd also want the underwriting to be pretty solid.

So I think while things could change based on where we see the spread [on] permanent capital right now, I do not anticipate that we'll be buying anything in the first quarter, and -- or until cap rates rise a fair amount or cost of permanent capital comes down a bit.

Cap rates may rise.

I mentioned this last quarter, but for myself, I have to keep looking at it to keep it in my thinking.

Next Tuesday is the 40th anniversary of Realty Income.

And I can go back over 40 years and look at where cap rates were every year, and it's kind of interesting.

And if you take the last four years, 2005 to 2009, and look at our acquisitions, which was over $1.5 billion, cap rates ran about 8.4% to 8.7% on the properties that we bought.

In 2003 and 2004, a couple of years before that, they averaged 9.5%.

And then, going back from 2003 all the way back to 1994, cap rates every year were in a range of 10.3% to about 11.3%.

Then I went back and dug out kind of previous to '94 when we went public, and in each year that the Company bought, from 1969 to 1994, cap rates were at 11% or slightly above.

So I think all of us have been kind of sensitized in the last few years to 7% and 8% caps.

And like a lot of assets in many other areas, I think they were really born of some historically cheap financing rates.

And moving up over 10% again seems probably appropriate, given what's happened in the credit markets.

And I wouldn't be surprised if it happened.

And we'll wait for awhile until we see that.

The other side of it, obviously, in this environment, which is fairly dynamic, to say the least, having cash and liquidity is a position that's a fairly attractive one, I think, for us and a lot of people right now.

Let me just talk about Crest quickly.

For those of you that are uninitiated, that's our subsidiary that we've operated for the last nine years or so, that would buy in and subsequently sell property.

We used it to buy big portfolios and then pair down our exposure to really maintain some diversification.

And it's been a regular part of our business.

Since we started it, it's made somewhere between $0.02 to $0.11 a share in FFO.

So, while it's been a fairly small part of our FFO, it's been in there.

We did earn $0.11 a share in Crest in '07; only $0.01 in '08 as we closed it down.

And if you've backed that out absent Crest, our core FFO was up for the year.

And during 2007, the inventory peaked at about $140 million.

And we've been paring it down the last 24 months, basically not buying in Crest.

As we said in the release, we're down to five properties for $6 million.

That's static from the third quarter.

We've -- kind of just letting the property sit there.

And they're available for sale, if anybody wants them, but not actively marketing in this market.

And effectively, we're kind of out of that business.

We think it's kind of a risky business today.

And while we don't like the $0.10 differential in FFO, as we closed Crest down between '07 and '08, I think if we had not closed it down, it'd have substantial inventory; we'd feel a lot worse about it.

So, in future calls, I probably won't say much about Crest at all because we effectively have it closed down now.

Let me comment on dividends for a moment, which seem to be a pretty good area of emphasis for a lot of people.

As you all know, dividends are very much the priority here at The Monthly Dividend Company.

We will pay our dividend in cash.

I think that's no surprise to most folks.

As most of our investors, some 70,000 rely on it to pay their bills, or so they tell us, and cash is the priority, as it has been for the last 40 years.

I would anticipate at this point that the dividend will be higher this year than next year.

How much will be dependent on operations.

This year than last year.

Excuse me, this year than last year.

And I also would hopefully say that it's our goal to have it higher in 2010 than 2009.

Dividends are really why we're here and it's a focus of the Company.

Paul commented on the balance sheet, paying off the $100 million of 8.25 notes and the $20 million of 8% notes with cash on hand.

We were glad to get that done.

And so we're out till 2013 before any debt comes due.

I think it's just $100 million in '13; there's none in '14.

So, we're in pretty good shape there.

And as Paul said, we have good cash on hand and no balance on the line.

So as we sit here today, the balance sheet's pretty simple.

There are no JVs or developments going and nothing off-balance sheet.

So the business is pretty straightforward.

Kind of the last area is on guidance.

We tweaked our estimate to $1.83 to $1.90 this quarter.

That is flat FFO growth to 3.8%.

And as I spent a lot of time talking about in the third quarter call, our estimates that we put out initially for '09, we put out the low end at no acquisitions for the year, since that's traditionally been a pretty good driver of FFO growth.

And then on the top end, it was $500 million or about $125 million a quarter.

As I mentioned a little earlier, we do not anticipate buying anything in the first quarter, so our guidance this time really runs from no acquisitions on the low side, and then we backed off the $500 million to $375 million.

And taking that $125 million of acquisitions out in the first quarter, obviously, that would have been the acquisitions for the year that contributed to the revenue side primarily.

And backing that out had an impact.

And then secondarily, what we also did, given our stance on acquisition right now, for the $125 million in the second quarter, we made the assumption that all of that would come in at the end of the quarter.

And that gets us then from 0 acquisitions to $375 million.

On the low end, or on both ends really, we've also assumed some additional vacancy or lower same-store rent growth for 2009, given the economy.

We have built anything that we can see now in the portfolio with our retailers into that number.

And to be frank, we also just added in another penny or two, assuming that something else will come down the line that we can't see right now; but I think where we sit right now, that's a pretty good estimate, absent any material changes.

And I'll leave it to everybody listening to figure out where the economy goes, and then we'll all have a better picture.

Obviously, it's challenging to have visibility for almost anybody out there today.

With long-term leases and a pretty good occupancy number, it's a little easier, but it is a dynamic environment.

To kind of summarize and, given the circumstances, we're pleased particularly with occupancy and where the portfolio sits.

It will be interesting to see how the year progresses.

And we all look forward, as I'm sure you do, to the economy getting better, whenever in the heck that is.

And with that, Michael, if you will, we'll go ahead and open it up to questions.

And if anybody would like to chat a bit, we'll do that.

All right, certainly.

So we will begin the question-and-answer session at this time.

(Operator Instructions).

Our first question is from the line of Michael Bilerman with Citigroup.

Please go ahead.(multiple speakers)

I'm sorry, Mr.

Bilerman?

Did you have a question?

Maybe we'll move on.

If Mike wants to get in, he can queue back up.

Sorry about that.

We'll move on.

Anthony Paolone with JPMorgan.

Please go ahead.

Okay, thanks, good afternoon.

I was looking -- if I look at your annualized revenues divided by the occupied number of stores, it's about $140,000 a year per store, it seems.

Can you give us a sense as to if a store goes dark, obviously you lose the $140,000, but how much expenses would you be on the hook for?

Yes.

It obviously varies, which I'm sure you know, but our kind of ballpark around the shop -- if you lose $1.00 of rent, you probably want to add on $0.20 or so in expenses.

And that's a pretty good rule of thumb.

And then it just depends on the property and age and what's going on in the part of the country it's in and whether it's a theater or a convenience store.

But that's a good ballpark -- if you lose $1.00 of rent, you probably want to add on another $0.20 in expenses.

Okay, great.

And then, I was wondering if you could put some parameters around your auto dealership exposure, in terms of maybe brands or domestics versus imports, things like that?

Sure.

Obviously, we don't get into great detail relative to the individual tenant, but the dealership is primarily one tenant, so it's a good-sized guy.

And he's kind of one of the largest, most successful in his business.

Fortunately, he's got a fairly strong service business and fair retail running off that, because sales throughout the dealership industry -- whether it's cars, boats, RVs, almost anything, any durable goods -- is just really severely impacted.

So that's the one, if you look at, in the third quarter where I said the range of cash flow coverages was 1.77 to the mid-4's, that's the one that's down at 1.22.

The good news, if you can call it good news, is that the 1.22, I think that's pretty much assuming no sales, and all of the revenue coming from the other sides of the business.

But that's an impacted one.

We're also fortunate that it's also somebody who has an extraordinarily good balance sheet.

Okay.

And then just last question along the same lines -- just movie theaters and how you're feeling about those and their performance these days?

Yes.

We feel very good about movie theaters.

That has turned out to be -- it's been speculated sometimes to be cheap entertainment.

And while people are doing a lot of what's ever required spending and basic human need/low price point, people don't stop entertaining themselves.

And so I think if you look at people cocooning a little more, but they're also getting out.

And when they get out, they're staying away from very expensive stuff.

But the theaters are doing pretty good.

If you look last year, I think they were off a little bit relative to traffic, but up in price.

And it's been a pretty good slate of movies out there, and content always drives box office.

So the numbers we're getting from our theaters are pretty good.

And we also had a group of theaters that had particularly high coverage, so we -- I don't think we have any issues there, Tony.

Okay.

Thank you.

Dustin Pizzo, Banc of America.

Tom, can you just maybe put some numbers around that vacancy loss assumption that you guys have in the guidance for us?

I know last quarter was -- you had mentioned, I think, 100 basis points.

Is that still sound about right or --?

Yes, we widened it out a little bit.

It's a full 1% and really up to 2%.

So, it's kind of a 1% to 2% bandwidth.

When we go to the 2% in kind of our model, if you will, that may assume a few acquisitions on the back end.

So, if you look at 0 acquisitions, then we're looking at kind of 1% to 1.5% occupancy loss.

Does that makes sense?

If you look at 0, you're looking at 1% and 1.5%.

Okay.

I mean, I guess I'm just trying to figure out -- if you take -- to get to the guidance, basically, if you take the run rate from this quarter and just annualize it, you essentially get to the low end of the guidance range.

So with no acquisitions and vacancy loss, I'm just trying to figure out --

Yes, our (multiple speakers) --

We had some vacancy loss.

We have some same-store rent growth.

We have less interest expense, et cetera.

Yes, our number eternally at -- with the 0 don't -- get us a little higher.

Okay.

And then when you look at those coverages that you mentioned earlier on, I mean, at what point, when you look at the, I guess, the midpoint of that [2.4] and in the low end, I mean, it looks like the midpoint was done about 15%, and the low end 30%.

I mean, at what point do you guys start to get concerned about potentially tenants coming back to try and either renegotiate leases or on the low end, bankruptcy type scenarios?

I mean, have you had increasing levels of concern there?

Any increasing conversations with your tenants recently?

I don't know that they're increasing.

We had a lot of discussions with them last year too.

But it's interesting.

I mentioned earlier, we've done 900 lease rollovers.

And that's when you get to the end of the lease and the tenants got a put on the property.

So we've got a big database.

And almost all of the time, if it was less than a 1 to 1, we got it back.

If it was a 1 to 1.25, they're going to want a rent cut or we're getting back.

At about 1.35, they start going, I really need a rent cut, I'd really like one, gee, this is my put opportunity.

But that's when they start going, I just don't want to give up that EBITDA, because it's positive.

And at 1.5, you're feeling okay.

Doesn't give you a huge margin of safety on the downside, but you're feeling okay.

So sitting up at 2.4 today and we've done a bunch of sensitivities.

We took the cash flow coverages of the top 15 and it averages 2.4.

And then had the Research Department say -- if you took a full 'nother turn of 10% drop in revenue out -- and by the way, a 10% drop in revenue impacts each industry dramatically different; in some, a 10% drop of revenue can take a 2.0 to a 1.2.

In another industry, a 10% drop takes a 2.0 to a 1.8.

But if you average it all out, if after the first quarter, you add another in, 10% drop of revenue, the 2.4 goes to about a 2.0.

And it's really -- at 2.0, we're still very comfortable.

And the reason we've never underwritten the 2.0 and we wanted it higher is to give us a margin of safety and now we are using it.

But as long as we are up around 2.0, then I'm comfortable.

It gets below that, I get a little more uncomfortable.

But at 1.5, the majority of the stores, somebody is not going to walk away from.

What happens, though, obviously is all of these you have a bell curve.

And if your bell curve is a 2.4 at the peak and a 3.77 on the right and a 1.22 on the left, when you do sit down with a retailer, the ones on the left side of the bell curve, you're going to be talking about a handful of properties with somebody.

And that's been absolutely typical over the years.

But at 2.4, we're still really high.

Jeff Donnelly, Wachovia Securities.

I guess, continuing that line of questioning, it used to be that you couldn't outright avoid retailers with financial issues but that second line of defense was at -- or at least from that lease owner, was to own the stores at the attractive level of economics.

But anecdotally, what we're hearing from other landlords, not necessarily just net lease landlords, is that retailers these days seem to be much more arbitrary around their decisions for closing stores, because it's more of a credit and liquidity for them.

I'm not sure if that's inventory driven or just balance sheet capacity driven.

But has that been your experience of late?

Have you found it to be less orderly?

It's been a little less orderly, and strangely enough, the old law of unintended consequences, the new bankruptcy law really tightened up the times they have to make those decisions.

So on the margin, as the time gets close, where they used to sit around and really hem and haw about properties and you'd get there at some point, now they do have to make a decision.

And it does cause them to maybe let a few go away where they hadn't before.

And we've seen a few of those in our numbers.

The other thing that comes up today is obviously -- and it's kind of come in two phases -- first which a lot of people filed and then what happened is the DIP financing or Debtor in Possession market kind of went away.

You went from about 14 lenders out there to 2 or 3.

And there have been a couple of cases you've seen out there where people couldn't get DIP financing and went right to Chapter 7.

What has happened now is that's eased up a little.

And then you've had some I'd say more aggressive individuals enter that market and kind of DIP to own.

So that's eased up a bit.

But it has been a little bit less orderly that it might have been in the past.

There's probably a few where some profitable properties went away because somebody couldn't get financing.

But generally, absent closing a region where you'll get a few, it still is high cash flow coverage and you end up in pretty good shape.

But you make a good point.

It is a little more messy today than it's been in past years.

I'm curious, I'm not sure if you're able to do this, but if you had to guess where industry-wide occupancy was, I guess, from the net lease business, let's say at year-end 2008, where do you guess -- standing where we are today, where do you guess that goes at year-end '09 and say, year-end 2010?

That's a pretty good guess and calls for a big macro call on the economy, which I don't have.

Fourth quarter was an absolute mess, which we all know, albeit really centered around those more consumer durable and non-discretionary.

First quarter, actually January to date, I think things haven't gotten materially worse, but they haven't gotten better.

And so then it's your macro call.

And I really -- I would say it's almost impossible for me to tell.

If you see the economy really start moving soft again, another round of job cuts takes it in the opposite direction, then you're probably going to see that down at around -- I would say our occupancy these days is higher than the industry in general.

If we're at 97%, I'd put the industry probably around 93%, 92%.

And I'm guessing here.

And you'd give it another good couple of bad turns in the economy and then I think the whole market might be around 93%, 92% or 91%.

And I would assume we'll be a couple points or something higher.

But I guess to put it differently, I mean, or maybe what I'm angling at is do you think that it's possible for the industry to shed 300 or 400 basis points of occupancy in a year?

Or does that just seem dramatic to you?

The answer is -- the generic industry, yes.

Okay?

I think if income is down -- you know, this underwriting to cash flow coverage is fairly unusual.

Although it may not seem to those who follow the REITs, because it's talked about.

We started doing it about, oh, 13, 14 years -- 15 years ago.

And to my knowledge, the guys at FFCA Spirit did it, very effectively.

And then a couple of other people in the last few years.

But I would say probably 90% of all of the net leases that are in existence, the landlord does not have the ability to look through and understand what the profitability of the unit is.

So, it's rather unusual.

We've underwritten to it, which has been very helpful.

So I could very much see another 200, 300, 400 basis points generically, but I think it would kind of bifurcate off, if you knew upfront, when you're underwriting, how profitable the properties are, and you ought to do a little better.

Are you willing to share at this point maybe what's happened with Realty Income's occupancy in the first 45 days of the year?

No, we report at the end of the quarter, as always.

Quite frankly, I thought it might tick down 10 basis points last quarter.

We had 12 properties go vacant last quarter, and much -- or excuse me, 9.

And much to my surprise, our leasing people had a very active quarter and leased 12.

And therein lies the difference between 96.9% and 97%.

So I wouldn't be surprised to see it tick down a bit, but nothing dramatic as of this point.

And again, I'm very pleased with the efforts of the people in our leasing department over the last few months in this market.

And I think I'll continue to be.

It's making a huge difference -- again on an apartment we put together, basically deal with lease rollover and I'm glad that we have.

That's helpful.

And just one last question.

And maybe this is looking down the road, who knows how long it is, but clearly, I know we're not through this predicament yet in the economy, and hopefully, there's another side to this chasm, but when we get to that point, are there operating or financing lessons that you guys have gleaned right now from your experiences thus far, that may be incorporated in that future view?

Yes, you know, it's kind of if just for being a little bit shell-shocked through a 100-year flood, you don't have some lessons that you'll hang on to, you're probably not human.

So, while we've always thought we wanted high cash flow coverages, I think that I'd want them equal or higher.

But on the low end, we would do deals in kind of at the [1.75] close-out at the low end for just a few properties if we really like them.

And I probably wouldn't do that again, but that's kind of minor in nature.

We've always really concentrated on the unsecured underwriting if we thought that they did get in trouble from a balance sheet perspective, that it'd definitely be an 11 and not a 7.

And I'd probably look at that even a little bit harder, as we've seen what's happened this time with folks.

Also, you sit there and you say we do basic human needs and low price points and that's the vast majority of everything we do, and then you always have two or three transactions you did in the seven-year period were out working.

And to be perfectly frank, there is one that kind of didn't fit the mold, but we had a good reason, and the good reason held up.

And then there were two where we now sit there and hit ourselves in the forehead and go, wait a minute; didn't this kind of like have two things against it?

And somehow, because of one property -- we bought this one and then somehow we did it again.

And so you just -- I think if -- we just go back and be even more strict in what we did.

But overall, I'd have to say I'm pretty pleased thus far on how well it's held up.

Aside from credit, any biases then towards geography or even by industry, like restaurants or Hawaii?

I have a definite prejudice for Hawaii, and I think it will take some due diligence on a senior level and a short-term basis [late tomorrow].

But no, geographically, you know it's funny; we both stayed kind of a little bit of a concentration in the South, in the West and the East, because you get economic growth and it bails you out of some dumb decisions.

And then you get a housing crisis in the area that you were looking at, that had the economic growth has the reverse of it, and you're glad that you stayed very well-diversified all the way around.

And as long as you're staying at basic human needs, there are people up in the Midwest, and that's actually the most stable part of the portfolio right now.

I just -- as we've identified, we continue to see -- you don't want to get too rural, I guess, unless you're in a convenience store on two state routes.

So, staying close to SMAs -- those are all little lessons of the margin stuff we knew, but maybe you could be a little more disciplined in the future than you were in the past

Okay, thank you, guys.

Michael Bilerman, Citigroup.

My phone working now?

(multiple speakers) There we go.

[Greg Schwartz] is on with me as well.

Tom, when you sort of look at the expiries this year, you have a much bigger percentage of guys who on their subsequent expirations that [have] renewed in the past versus the initials.

Can you drill down a little bit, in looking at your expirations this year and sort of tying that with 100, 150 basis point occupancy loss coming up with your forecast?

Thank God that two-thirds of them are second rolls.

In this market, the second roll has always been better.

These are properties that have been once and they wanted them because they make them a lot of money.

And we think that's the case.

We just went through this in portfolio management and we think it's breakeven to maybe down a point.

We think we're going to retain the vast majority and we don't look at that as really where the occupancy change might come.

I think if it comes, it's going to be in default, not on rollover.

We feel very good about rollover.

And then -- so this is 4% of rents.

How much square footage does that actually represent?

It's probably a little less then that.

Less than 4% square footage?

So they're above market rates?

No, no.

They're just smaller buildings.

That's another way to look at it.

I think Greg had some questions also.

Sure.

I know you guys aren't talking about tenant specifics, but just touching on Liberty, there's a lot going on in Australia right now with ABC Learning, about 25% of the assets are -- their receivers are looking at non-binding offers to buy out those properties.

Could you just provide a bit of color on what's happening with the US assets and maybe specifically your exposure?

Yes.

As we went through in some detail last year when ABC went up, there was a lot of misconceptions relative to what was going on there in the US.

The US units that we own are fairly strong.

I don't have a concern about them.

And last year, ABC sold the majority interest in the US company, so they are no longer the owner of it; they're a minority owner.

And any color that you can provide on how your assets are performing, maybe cash flow coverages?

We don't give them out per individual tenants, but they're performing adequately.

They've been in the portfolio now for, in most cases, for over 20 years.

So those were properties that were purchased at very low prices many years ago -- Gary, do you remember what the average cost for those is?

Around $400,000.

Yes, the average cost of our units -- this is really important -- is about $400,000, $500,000, where replacement costs today for a newer unit, you'd be looking at $1 million, $1.2 million, $1.3 million.

So even with some rent increases, you're really looking at those being on the very low end of the rents they pay.

And amazingly enough, there's pretty good correlation between profitability and low rent.

So, I can just tell you that coverages are probably not up to our average, but they're very comfortable.

Okay.

Thanks.

And just one more -- any tenant that you put on the watchlist that you're a little bit concerned about?

Well, we have a couple of tenants on the watchlist, but nobody eminent.

And what we've done, although we don't know if there's going to be an impact, we put what we thought would be the impact in guidance and then added some more in.

But nobody eminent that I'm aware of today that would have a meaningful impact on us outside of what we've got in guidance.

Scott Coleman, [Creative Capital Management].

Asked and answered.

Thank you.

(Operator Instructions).

Tom Coleman, Kensico Capital Management.

All the properties you have for sale in Crest, are they all vacant?

No, we only have five -- we've had up to 120.

Three of them are former Buffets, they're vacant.

But for those of you who will recall, a couple of quarters ago, we impaired them by over 50% in value.

So those are vacant, but we wrote them down by half.

The other two are fully occupied, paying rent and pretty good properties, so there are only five.

And then the properties that you offer for sale that are vacant that aren't in Crest, what does that mean?

They're just on the balance sheet -- how are they presented differently in the financial statements?

They're just properties in the portfolio.

Yes, you would find them just in our real estate portfolio on the balance sheet.

Because in actuality, they are consistently marketed for sale or for lease with the preference toward lease.

We like to generate income to pay on dividends.

So, when you look at our balance sheet, you're not going to find them in the for-sale category; that's going to be the Crest stuff at the moment.

There might be one or two from the REIT where it's clear that's what it is, a for-sale property.

Maybe there's an LOI in place we're moving forward with, and it would fall into that.

But otherwise, you're going to find the REIT vacant properties in the real estate held for investment.

Yes, if you look at the 12 that -- there were, of the -- let's see, there were 12 that went out of the vacant category and nine were re-leased and three were sold.

And if you look at the sales last year, the majority were not vacant properties; they were occupied properties.

And the prices that you're offering those at, did they relate in any way to the GAAP value of that property?

We have tended to sell the properties at a GAAP gain.

And that has been the case this year too.

[Net].

Okay, thank you.

Rich Moore, RBC Capital Markets.

I'm curious, Tom, if the credit markets come roaring back suddenly or if cap rates shoot higher, I mean how quickly do you actually begin closing on things?

Are you actively reviewing a lot of portfolios?

Or how is that working right now?

You know, realistically, it probably -- it could be inside but I say, I think 60 to 90.

We have transactions that are coming over the transom.

We have things downstairs we're looking at right that get reviewed.

So it's merely a decision to say, here's the cap rate and yes, we're buying.

And we would be at the right price.

But last year, as an example, we stopped buying in the second quarter and we bought $189 million.

We still had $5 billion go through the Committee last year.

So, the number of transactions reviewed last year was roughly equivalent to what it was the year before, when we bought $533 million.

So we keep the flow going through.

What we do is we cut it off about half-way through, because we don't want people to think that we're going to close when we're not.

But we are actively reviewing.

If the prices were right, we would actively go.

But I think if I said today, boy, look at where cap rates got.

And we'd want to go, I think you'd be looking at 60 to 90 days is a good guess.

Okay.

And then you kind of mentioned, I think, that maybe 9 to 10 is what you're seeing at the moment.

And I assume that's some kind of average.

Are you seeing anything at all that's attractive in the 11% range?

Or is there nothing up there yet?

No.

How was that?

Yes.

That's fair.

That's very fair.

And I certainly know where interest rates are and financing costs.

So, anyway, great.

Thank you, guys, very much.

You bet.

All right.

Thank you, Mr.

Lewis.

There are no further questions at this time.

Please continue with any closing comments.

Okay, well, thank you, everybody.

I think again we were fortunate this quarter.

We'll all watch the economy and we operate in the same one as everyone else, and we'll manage the portfolio and see how we sit next quarter.

It's a dynamic environment.

Thank you all very much.

Thank you.

Ladies and gentlemen, this concludes the Realty Income fourth quarter earnings conference call.

You may now disconnect.

Have a very pleasant rest of your day.