Realty Income Corp (O) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen.

Thank you for standing by.

Welcome to the Realty Income third quarter 2009 earnings conference call.

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

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

(Operator instructions) I would now like to turn the conference over to Tom Lewis, CEO of Realty Income.

Please go ahead, sir.

Thank you very much, Jeremy.

Good afternoon, everybody and welcome to the conference call.

And as was said, we'll try and run through the third quarter results.

And with me in the room today is Paul Meurer, our Executive Vice President and Chief Financial Officer; Mike Pfeiffer, our Executive Vice President and General Counsel, and as always, and Tere Miller, our Vice President, Corporate Communications.

And, as I'm obligated to do, I will say that during the conference call, we will be making 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 any forward-looking statements.

We will disclose in greater deal in the Company's quarterly and Form 10-Q the factors that may cause such differences.

We'll have Paul start out and begin with the overview of the numbers.

Paul?

Thanks, Tom.

As usual, let me comment on the financial statements and just provide a few highlights of our financial results for the quarter, starting with the income statement.

Total revenue remained flat at around $82 million and this is primarily because we've sold 24 properties over the past year and have acquired only three additional new properties.

We own 2,355 properties at September 30th of last year, while we own only 2,334 properties today.

Same store rental revenue increased 0.4% for the quarterly and year-to-date periods.

On the expense side, depreciation and amortization expense increased by $176,000 in the comparative quarterly period.

Interest expense decreased for the quarter to $21.4 million.

This reduction reflects of course the retirement of $120 million of our bonds over the past year.

We continue to have zero borrowings on our credit facility and on a and on a related note, our coverage ratios remained strong, with interest coverage at 3.5 times and fixed charge coverage at 2.7 times.

General and administrative, or G&A expenses in the third quarter decreased by $191,000 and we continue to expect G&A expenses in 2009 to remain flat or lower as compared to 2008 at only about 6.5% of total revenues.

Property expenses decreased by $102,000 to about $1.6 million for the quarter as these expenses have continually decreased each quarter since the beginning of the year.

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

Our current estimate for property [debt] expenses for all of 2009 is about $7.4 million and our estimate for 2010 however, is significantly lower at approximately $6 million or back really to 2008 levels.

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

These taxes totaled $74,000 for the quarterly period.

Income from discontinued operations for the quarter totaled $2.1 million.

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

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

Overall, Crest contributed income or FFO of $207,000 in the quarter.

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

We sold seven properties during the third quarter, resulting overall in income of approximately $1.9 million.

However, these property sales gains are not included in our funds from operations.

Preferred stock cash dividends remained at $6.1 million for the quarter.

Net income available to common stockholders was $27.1 million for the quarter.

Funds from operations, or FFO, was approximately $48.2 million for the quarter.

FFO per share was $0.47, an increase of 2.2% in a comparative quarterly period.

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

Our AFFO, or the actual cash we generate, which is available to pay out as dividends as usual is higher this quarter than our FFO.

This is typical because as I've always said, our capital expenditures are very low and we have very minimal straight-line rent in our portfolio.

We increased our cash monthly dividend again this quarter.

We have increased the dividend 48 consecutive quarters and 55 times overall since we went public 15 years ago.

Our dividend payout ratio for the quarter was 90.9% of our FFO and even lower on an AFFO basis.

And now let's turn to the balance sheet briefly.

We've continued to maintain a very conservative and safe capital structure.

Our debt to total market capitalization today is about 30%, and our preferred stock outstanding represents just 8% of our capital structure.

And of course, all of these liabilities are fixed-rate obligations.

We continue to have zero borrowings on our $355 million credit facility.

And this facility also has a $100 million accordion expansion feature.

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

We have $20 million of cash on hand at the end of the quarter, and 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 for almost four years.

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

Thanks, Paul.

Why don't I start with the portfolio and just generally say that the portfolio is doing very well, given the state of retail today.

I think our tenants have generally seen their business stabilize a bit over the last couple of quarters and so far here in the fourth quarter that remains the case and as we talk to them there seems to be a bit more positive tone about where they are today.

And I think for them it's really the comment of the new normal and flat's the new up.

And since they haven't seen declines and they've had a little more positive vent in their business they seem to be a lot more positive.

But I don't want to get carried away relative to what they're saying.

I think they're just more relieved than anything else.

We worked with a few of them over the last 18 months or so to get through issues that have hit some of them during the recession.

Fortunately we missed most of the failures that have occurred out there in retail and in the cases where we have properties with retailers that did have problems we generally have owned their more profitable properties, which means that we were impacted much less than others might have been or some might have expected.

I'm also really happy to say that as we sit here in the fourth quarter, none of that is going on in the portfolio as of right now.

All the tenants today are current with their rent.

We have no discussions going on at all with any of the tenants about problems paying their rent or a desire for rent reductions.

There's nobody in Chapter 11 that we're talking to about problems with their properties.

And it is unusually quiet in the portfolio and clearly a more positive environment relative to their operations and what's going on in their business as it impacts us than maybe over the last 18 months, which has been very nice to see.

We often talk about owning the more profitable properties in their portfolio and that really focuses around looking down to the store level cash flows and having a good idea of how profitable our properties are to the retailers, which is really the key as to how we perform in the long-term.

And our largest 15 tenants, to use those as an example, as we frequently do, do about 52.9% of our revenues and at the end of the third quarter the average cash flow coverage in those 15 largest tenants was just under 2.5 times or about $2.50 in cash flow that they produce off the stores on average that we own with them for every $1.00 they pay in rent.

And I think really that those coverages are why the portfolio's done pretty well over the last 18 months or so.

And really over the long-term for the Company.

We ended the third quarter with 96.8% occupancy and with 75 properties available for lease.

That's out of 2,334 properties.

It's up about 20 basis points from last quarter to 96.8% and just around where we were pretty much in the portfolio a year ago, which I think is positive.

Same store rents continue to increase, up about 0.4% and that includes the reductions that we did a year ago with Buffets as they went through their Chapter 11.

Absent that, it would have been a little higher.

Our sense is right now looking into our crystal ball for the fourth quarter that we should see same store rent growth being positive in that quarter and for the coming quarters, albeit at a modest rate really as we've seen over the last year and I think you'd expect in this type of environment.

To give you an idea same store increases came from, of the 30 retail industries we have in the portfolio, seven had declining same store rents, restaurants were most of it primarily coming from the Buffets renegotiation.

Two of the industries have flat same store rents, and then 21 of the industries in the portfolio had rent increases with the majority coming from convenience stores, tire store, childcare, and then health and fitness were the largest contributors.

And I think the general theme we see in our portfolio and we continue to hear from the retailers is the kind of basics goods and services that people buy on a regular basis at low price points seem to be certainly outperforming the results of those people that have more discretionary and durable good types businesses.

And that seems to be a good part of our portfolio in the low price point.

Relative to the diversification of the portfolio, we continue to have good diversification.

Out of the 2,334 properties, they represent 30 different industries, and 118 different chains, and in 49 states.

The industry exposures remain pretty balanced.

The largest industry is still restaurants, which is at 21.2%.

That's down a bit from the end of the year and we'll continue to work that number down.

If you break that out, about 12% of that is in family restaurants or what a lot of people call casual dining.

About half of that is Buffets.

About 1% is in dinner houses, and then the other 8% is in fast food, which seems to be over performing the rest of the restaurant industry.

Convenience stores are at 17%.

They've been up a bit due to pretty much across-the-board rent increases this year that we've seen from them.

Theaters at 9.2% and then childcare, which was -- has been in our portfolio an awfully long time is down to 7.6%.

From a tenant standpoint, the largest tenant in the portfolio is just over 6%.

The next one is 5%, and it goes down pretty quickly from there.

If you take our top 15 tenants, again it's about 52.9% of revenues.

When you get to the 15th largest tenant, you're talking about 2% of rent and everybody else in the portfolio is below 2%.

So I think pretty well diversified out there, which has been helpful.

Average remaining lease term's about 11.3 years.

That's nice to have in this environment.

And so as we look at the portfolio, given the tone from the tenants, really not anything going on in the portfolio today.

And occupancy healthy and same store rents up.

We feel pretty good about where we sit with it here in the fourth quarter.

And I think kind of looking forward to the end of this quarter we really think that we'll see continued high occupancy and modest same-store rent growth.

Kind of the other major thing to talk about today is property acquisitions.

And after 20 plus months of not buying property and waiting to see if prices would adjust and cap rates get a little better, we have started acquiring again pretty much on a modest basis.

You saw in the release during the third quarter we bought three properties for just short of $11 million at just over a 10 cap rate.

That transaction was one where a tenant had some immediate cash needs and we were able to go in and help them solve their problem at a pretty good rate of return.

And was really us getting started again in acquisitions.

And it's kind of interesting.

We continue to look at additional transactions.

I think we'll buy some properties here in the fourth quarter.

And there are a number of transactions in the marketplace that we're looking at today.

But if you look at overall volume, I'd have to say it's certainly modest compared to a few years ago.

And of the transactions that you do see out there now, I think a number of them still are some people coming to market with some immediate financing needs that might not meet the quality of some of the portfolio acquisitions we would want to make.

However we are starting to see some people tiptoe back into the market with some larger transactions.

And I'd really say bite size kind of in the $10 million to $50 million range is what we're seeing out there.

Cap rates seem to have stabilized in these portfolio transactions, kind of in the 9% to 10% cap rate range, and that's how they're coming out.

And depending on what they are, the size, the immediacy of need will kind of tell you whether they're trying to play closer to the 9% side or to the 10% side of that.

So while I do see transactions moving up a bit, I think it still is pretty modest.

I don't think there's a rush of sellers, however there are not a lot of buyers out there either, so from a competitive standpoint I think we're in decent shape to compete on the transactions.

Relative to themes along industry lines, there doesn't seem to be a lot there.

I think we did -- anybody could buy a lot of restaurants today.

That's not in our target given concentration levels.

And outside of that, most of what we see is I think balance sheet generated as yet folks that are looking, needing to do some financing in the months coming up that are starting to come out into the market.

And as that continues and you see kind of general balance sheet with financing needed to be done over the next year or so, we think that will probably accelerate the number of transactions that we see out there in the market.

But till pretty modest to date.

Moving onto dividends, as always that's a priority for us.

And I'd anticipate that the cash dividend would be higher this year than last year and higher next year than this year.

And that is why we're here and what the shareholders look for.

Paul commented on the balance sheet.

We did spend about $10 million in cash during the quarter on those acquisitions.

We have $20 million in cash sitting there today.

Continue to have no balance on the $355 million line and with no debt due, or mortgages, or developments JVs, obviously very liquid and able to act should we see something attractive coming up.

Let me move onto guidance.

For 2009 we tweaked the estimate to the $1.83, $1.84 and that's flat to about 0.5% FFO growth.

And as we pretty much said over the last year, our estimate range on the low side was from zero acquisitions and then kind of up to $125 million a quarter.

And since we bought very little this year and quite frankly since I think anything we might buy in the fourth quarter's likely to close fairly late in the quarter, the impact to incremental acquisitions this year would be very small.

And so we think the $1.83 to $1.84 is probably a good level, given the stability that we're seeing in the portfolio right now.

Also, it's pretty interesting to look at the Company right now and it's one of those moments in time where you say, we really haven't bought property over the last 20 months or so.

Our Crest Net Lease subsidiary has been essentially shut down.

There's really not been any cost cutting going on in the Company.

And pretty much what you're seeing in the Company's operation is our core operations on the portfolio in what is pretty deep into a tough recession.

And I think things have held up pretty well.

So it's a good time to observe the portfolio before we go out and start buying again, which then mixes up the numbers a bit.

We're also initiating our 2010 estimates in there at $1.86 to $1.92.

Or 1% to 5% FFO growth.

And I think that assumes pretty good continued stability in the portfolio, which is what we are seeing at the end of the year now.

And then also consistent with acquisitions on the low side being very modest next year, maybe zero.

And then on the higher side, $250 million to get to those numbers.

I would say however, unlike the beginning of last year when we were out of the acquisitions market, I'd certainly think we'd be more acquisitive in 2010 than we were in 2009.

The $250 million is not a target, it just was a range from which we could generate some guidance numbers and as we get further into 2010 we'll see if we're below the $250 million or above the $250 million and really what happens then.

To kind of summarize operations, we're real pleased with the stability portfolio and occupancy and same store rent growth.

Balance sheet's in good condition.

And then basically a good quarter and a quiet portfolio.

And if we can start seeing over the next couple of quarters some acquisition opportunities, that will allow us to accelerate the business a little bit.

And with that, I think we'll go ahead and open it up to questions.

Thank you, sir.

Our first question comes from the line of Jeff Donnelly with Wells Fargo.

Please go ahead.

Good afternoon, guys.

Hey, Jeff.

Tom, you touched on it a little bit in your comments, I guess.

And I had asked you last quarter I think where you thought we were in the cycle of store closures and bankruptcies.

And I guess I'm curious, has your view changed at all I guess in the last 90 days?

Have you become more encouraged?

Or discouraged?

Well, I like the idea that we're not dealing with any of them today, which we have been dealing with over the last 18 months.

But I think like everybody in the industry today, you spend your time kind of doing scenario planning and are you in the camp of is it flattening out, going to be a V or a W?

And my answer, right, is I really don't know.

It wouldn't surprise me to see some continued bankruptcies over the next year or so absent things really picking up.

As we look out there, you see just a little tweak on the durable goods side getting a tiny bit better, but not much at all.

And generally I think people just quite declining and up a little bit.

So I don't -- I really -- I'm not so sure that we're in a stage where gee, it's recovery from here.

I just think things quit getting worse and some of the retailers that were going to have problems have them.

Is there anything you can share with us I guess on the market for dips financing?

Because anecdotally we continue to hear that it's been challenging for retailers to obtain that sort of financing.

That's what's been holding off restructuring.

Do you think there's truth to that?

Or do you have any I guess insight there?

I think dip financing is certainly more easier to get than it was earlier in the year.

We were involved in a couple of Chapter 11s where we sat on the committee and chaired one committee.

And if you go back to January and February, it was a period where I think in every one you looked at the Company had to work very hard to go out and get their dip financing.

And if you look today, the ones we hear about people are able to get it a little easier and it's opened up a bit.

Just last question is I'm just curious.

You have a little over I think 11 years on remaining lease term on all your existing leases.

I can't recall, but it -- has that fluctuated much over time?

And I guess I'm curious from a portfolio management standpoint.

Do you take that into consideration when -- I guess as you think about acquisitions and you manage your portfolio?

Because I would imagine shorter lease terms become more challenging to finance your buyers over time.

Yes, generally we're a seller primarily of properties when we have a problem with them and tend not to be out selling a lot on a regular basis, so it doesn't impact us as much.

We're very much a hold for long-term income production.

But it -- that number's -- if you looking the annual report, you can kind of see it and it just kept kind of going up over the years as we continued to buy.

And about six, seven years ago we really started moving to 20-year initial lease terms more than we did 15.

And we were buying a lot, so that really expanded out.

The second thing that happened is as we started having lease rollovers, you get like this year's lease rollovers that have a month, or two, or three left and they weight that average down.

And then as soon as you write a new lease that's three and usually five years, it goes back up again.

Over the last 20 months when we haven't been buying, it's kind of gone from 12 years down into the low 11s.

And now it'll be a mix depending on how much we're really buying.

But let me try and -- absent kind of steady -- if you put steady acquisitions in, not absent, over the years as we get larger and acquisitions are steady, and as the portfolio matures, I do think you see the lease terms getting shorter and you have more of the leases turning over each year.

It's more of an issue I think for eight, nine, 10 years down the road and the interesting thing is though you really have to bifurcate the lease rollovers because if it's the first lease rollover after the end of a 15, 20-year lease, generally it's a more challenging roll than one that is rolling for the second time where they already had a put on the property and the ones that they're getting now are more profitable.

So long and short, as we get out and buy again now, maybe it'll move up again.

Thank you.

Thank you.

Our next question comes from the line of Anthony Paolone.

Please go ahead.

Hi, thanks.

Good afternoon.

My -- Tom, I just wanted to understand, you had mentioned you'd given the rent increases and decreases by industry.

Was that just the revenues that those properties produced in the last quarter versus, I guess, the prior year?

Or was that actually on leases signed in those industries?

I guess I just didn't understand what that measure was.

Yes, that measure -- same store rent increases, just the same store properties that were occupied and what the rents were this year versus last year.

So if you look across at the rent increases that we got -- we're in the industries I mentioned -- and that's just the same properties.

That's not on new leases signed, that's on the ones that are existing.

I think if you look at new leases signed, you're probably looking at lower.

We sign new leases when we buy properties.

Those actually would be higher today, but we haven't bought much.

But in terms of looking to lease rollovers, that ebbs and flows and generally has been a lease roll down to over the last couple of years when it picked back up again.

And we started the year kind of thinking rollovers were going to be a breakeven.

I think now we have a -- we're thinking more to about a 4% rent roll down and as we get late in the year and we look at lease rollovers, I think we have 2.6% of leases rolling over here in the fourth quarter.

And that's our sense on that and that's what we've put into guidance.

Okay.

Got it.

And that was my next question was on the 2.6% rolling over in the fourth quarter.

I mean that's -- it's about the level that you typically have on a full-year.

Is that just a matter of mix and timing?

Or how should we think about that?

Yes, that's exactly what it is.

It's just mix and timing.

There was some third quarter ones that the people also had some fourth quarter rollovers, and so they've just taken those, some of them month-to-month for a short period of time where we kind of do a global on it.

But if you look at it there are 92 leases.

70 are second rolls and very profitable properties, so my sense is those are going to go down pretty smoothly.

And some of them went right after the end of September 30 and we're pretty far the pike on them.

So my sense is that you're not going see a meaningful change in occupancy as a function of those roles in the fourth quarter.

Okay.

And then on your 2010 guidance, just a couple of items.

One, do you assume much in the way of an occupancy change either up or down in the portfolio?

We --

About 1% down is part of the assumption there.

And I'm not so sure we think (inaudible).

It's not predicting that, but in terms of the projections we're assuming say about 1% we have issues with.

And we'd be happy not to have it.

Got it.

And any major change in G&A next year?

No, about the same.

About 6.5% to 7% of revenues.

We have a plug now of about $25 million and that -- but it really depends on acquisitions.

It'll be lower if there's a lower acquisition volume number or it'll be a full $25 million, maybe a little bit more if we have a lot of acquisitions.

Because acquisition commissions are in that number.

Okay.

And then just last question.

Give a sense as to maybe what portion of your leases have tenants where they're leveraged through maybe an LBO and might have upcoming debt maturities that you think about.

Just like what portion of the portfolio that might be.

Yes, I think there's a fair amount of it that is represented that way.

As you know over the last 40 years pretty much everybody we've worked with has been less than investment grade and I think you look out over the next two, three years, they like most people out there have some maturities that they're going to have to deal with and work on.

So I think it's fairly widespread in the portfolio, which I think we've been fairly up front about.

Okay.

And appreciate the extra disclosure on the tenancy.

Thank you.

Our pleasure and thank you for those people's input to -- gave it to us quite firmly and occasionally you need that and I appreciate it.

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

Please go ahead.

Hi guys.

It's Greg Schweitzer here.

Hey, Greg.

Tom, just talk to me about the acquisitions that you did this quarter.

What type of industry were ready assets that you acquired in?

As primarily health and fitness.

And obviously there weren't a lot, so that's an area that we continue to be focused on and we liked a lot.

And you said those were more to do with specific problems with those tenants.

Not a problem with the tenant, it's just that they had some debt coming due and needed some money, and had them on the balance sheet, and it was an opportunity that we could help them out with very quickly.

But I wouldn't put it as a problem they had they just needed some capital.

Right.

Could you provide a bit more detail into the sort of deals that you have seen across the desk this quarter?

The process on how you sift through them, if that's changed at all?

Yes, I don't know that it's really changed.

I know that we're not focusing on restaurants at all.

The only thing that's really changed is we had a few more one off property things come through that we'll take a look at.

And that's really a function of the vast majority of the buyers in triple net leases over the last six, seven, eight years have been guys doing 1031 exchange, buying one or two properties.

And they pretty exited the marketplace en masse.

And that primarily is a function of not having sold properties with gains anymore.

And so you see a few more one offs and so that's one difference.

And then you tend not to see a lot of big M&A transactions.

There are a few rumbling, but -- so I think it's rather than the $100 million to $200 million portfolio as you look out more of them -- most of them are more bite size and I describe kind of as the $10 million to $50 million to $60 million size transaction.

And it's really viewed I think by the tenants as more of financing that they're doing.

It's been a question from them, do they have access to the bond markets, do they have access to the banks markets?

Certainly don't have access to CMBS, but they might have a few years ago.

And so they're coming out and testing the waters there.

I'll also say though that as you look as the debt markets have opened up, and I think some of the people have been able to access the high-yield market more, I think most of them have had a little pressure taken off and maybe there hasn't the volume come to market that you thought there would be.

But outside of that, they look pretty much like what we were looking at a couple of years ago.

The cap rate is different and then I think tenants are a little more open to us discussing with them that the cash flow coverages need to be a little higher than maybe where they were a couple of years ago.

If you -- you probably took the average over the last three, four years the coverages we were buying at was around 2.5 overall on a portfolio.

And then the spread was kind of 1.75 up to whatever, 3 or 4.

And as you look today, it's 2.5 plus and you're probably looking on the low side that if they have properties today that are below much of a 2 coverage, you're saying to them that you don't really want them and unlike a couple of years ago, the comment you get back is not, "Okay, I'll sell them to someone else" because there's not a lot of buyers.

Okay, thanks.

And could you provide some more just general industry color specifically on the auto and tire services, home improvement, and health and fitness exposure?

Yes.

I mean if you -- let me glance at the press release here and get back to those pages.

Maybe we can go through them kind of one-by-one.

You want to give me those industries again?

Auto and tire service.

Yes, auto and tire service.

You see there's 6.8%.

You noticed in our disclosure that we did mention TBC, which is a very large (inaudible) by Sumitomo and is a very large seller of tires.

And they're a primary tenant there.

And then we have a number of other chains.

They're the one that's over -- that approaches 2% and the rest is below them.

And we have four or five tenants in there.

Their business generally has been hurt initially by the recession because I think on a marginal basis they make their money when somebody comes in and buys some rims or upgrades tires.

And what you found is people stepping back away from that and then trying to defer buying tires.

And now what you're seeing in the cycle is that the folks that didn't go out and buy new cars and kept driving their car, now they're having to replace the tires.

And they tend to be doing okay.

I wouldn't say it's great, but okay.

But I'd also say we have pretty good coverages in those stores.

How about auto service without the tires?

Yes, auto service is kind of the same business for it.

The lube business, which we have a little bit of, is probably a little more meaningfully impacted because they used to come in with a cheap lube and try to sell up.

And I think the consumer's more resistent.

But we really haven't heard any noise there out of the tenant.

And then in the repair area, it's kind of the same thing.

People put off repairs early on but we're getting deep into the recession, you don't buy a new car.

And they seem to be doing a little bit better there.

But I wouldn't paint it as doing great.

They're doing okay.

And then the other two, home improvement and health and fitness.

Yes, home improvement for us is actually doing okay because some hardware stores that we have.

And it tends not to be a lot of home improvement, it's more kind of hardware, but we tuck them into that one.

And they've reported to us that their business isn't bad.

And that's kind of the majority of in there.

And what was the last one?

I'm sorry.

The gyms.

The gyms are doing fine.

We have -- our primary tenant there is LA Fitness and they're a 300, I think 49-unit chain that we've dealt with since they had 40 units.

And they've rolled out across the United States.

That industry is generally doing pretty good, but it's bifurcated, depending on the revenue structure of how these guys book their revenue and what they're selling.

And those that were the really fancy gyms with a lot of add on services that were sold and products I think have seen a softening while the overall membership has held up okay.

But these guys are kind of bread and butter, which is basically working out and training.

They have a really good store and a really good model.

And they've kept their profitability up very nicely.

Our other tenant in the industry has had some problems, but we were able four or five years ago to kind of cherry pick off six or seven of their very profitable properties.

So we like that industry, the baby boomers seem to be migrating to it as they realize they're not going to forever.

And generally these guys have held up pretty good when we look at the numbers.

That helps a lot.

Thank you.

Our next question comes from the line of David Fick with Stifel Nicolaus.

Please go ahead.

Thank you.

Good afternoon and I'd like to second the appreciation for the added disclosure.

Tom, I'm wondering if you might care to comment on some of the public statements that have been made by some short investors in your stock.

I know you've been getting calls from investors about that as well as the Barron's article that occurred this quarter.

Any response to the specific commentary that's been out there regarding tenant quality and your business model?

Yes, I'll kind of do a wandering response maybe because I don't have anything specific.

First of all, just relative to short positions, I got in the securities business in the '70s and one of the things we understand about the public market is people are always long, people are short.

You're going to have people with buy ratings, sell ratings, and neutral.

And between that and buying/selling, that's kind of what makes up liquidity and valuation, which is great.

And generally we've been very well treated by the market.

And quite frankly, I think we continue to be so.

But I think overall, I kind of get the mathematics of the simple story, which is real estate plus retail, plus less than investment grade tenants, plus recession might equal short or a problem.

And I think there is a pretty good disconnect out there in the market.

And it's not atypical for people that are fairly new to looking at the Company about how we fare with our tenants that are less than investment grade generally versus the unsecured debt and the equity of those people.

And maybe a good way to talk about it, David, is just kind of talk about bankruptcy and kind of our history there.

Is that a kind of a good way to go?

Sure.

Okay.

It's kind of interesting.

In 40 years we've worked almost exclusively with less than investment grade tenants.

Occupancy has never been below 96% and it's at 96.8% today.

And I think it's interesting to note that tenants having problems having bankruptcies has been a normal part of our business pretty much as long as we've been in business.

And I think we understand the process and what happens.

And I also think that we understand that then this perception really lies and that the equity gets hit pretty hard when these guys go into bankruptcy.

The debt gets substantially refigured and we tend to do pretty well.

And first I'll just kind of give you the numbers.

Since we went public 15 years ago we have had 22 of our tenants file for bankruptcy.

Those 22 tenants represented 33% of our revenue.

Not all of them obviously went at the same time, but you take them en masse for those 22 and at the time they went you add them all up.

It's a third of our revenue.

And they've -- that represented 414 properties over that period of time.

322 of them, or 78% were accepted in bankruptcy, which meant there was very little that happened to us on those properties.

And we kept leasing those and obviously got paid during the reorganization.

92 were rejected, which is 22% of the properties.

And if you take the 22 bankruptcies in the year after the end of the bankruptcy and we got paid rent during the bankruptcy and we recaptured 89% of the pre-bankruptcy rent.

So as the landlord and in particular with the landlord with the profitable stores, we have tended to do better than one might have thought.

And the interesting thing, you take those 15 years and those tenants, and I think that period of time our FFO went up about 80% and our dividends went up about 75%.

And so we know how the process works.

It's a normal part of the business.

I think kind of the second question for the few people who've done some work on this is to then say, okay that's great, but today's different.

It's a harder environment, we're in recession, the consumer is worse off.

And so let me just kind of -- little additional disclosure.

Take the last 18 months and I'll kind of walk you through.

In 2008 and 2009, which is pretty good during the middle of the recession, we had six of our tenants in our portfolio that filed for bankruptcy.

The six tenants over the last 18 months represented 12.6% of our revenue.

This time it was pretty much all at the same time.

It involved 208 properties, 172 of the properties were accepted.

That's 83%.

36 were rejected.

That's 17%.

And if you look at the six bankruptcies, the recapture is about 83.3% of pre-filing rents in the year following.

So kind of six tenants, 12.6% of revenue and 83% recapture during the last 18 months.

And as I mentioned before, during the process, we generally get administrative rents on the properties.

So if you kind of look over the 15-year period the recapture rate's about 89% and I think 78% of the properties were accepted.

If you look over the last 18 months, which was six of these Chapter 11s, you've had 83% accepted.

Actually a little higher rent -- rate, but I think the recapture rate a little lower that one might accept during the recession.

And if you relate it back to what I said earlier, it's kind of interesting, given we haven't bought anything and Crest isn't doing anything.

And we haven't cut expenses.

You can get an idea of deep into a recession having 12.6% of our revenue with tenants in bankruptcy, what happens to the FFO, which it's fairly flat over the last year, same store rent up a bit.

Occupancy basically flat.

So I think that might be illuminating for some of the folks out there.

Very helpful.

One specific question.

In going through your form 3, we noted that you've got a handful of entertainment properties or properties listed as entertainment that have a fairly large land base and minimal construction or building improvements.

What is the nature of those assets as it just categorized as entertainment?

Yes, those have been in the portfolio for a long time.

And generally those are a combination.

They're primarily small properties located on freeways where you've got miniature golf, you've got go-carts and you've got a wide variety of entertainment.

And a couple of chains that we've worked with -- just I don't think we've bought any of those in five, six, seven years.

But what we did when we went in and looked at those is we looked at them primarily on a land basis and not paying for the improvements because obviously the improvements are a little difficult to lease to somebody else for a different purpose.

And basically tried to value the land and the surrounding areas and pay that.

And then what we did is we wrote a very long-term triple net lease on it.

And the net effect to it is the cash flow coverages were extraordinarily high and it was a way we could own the land and quite frankly over time prices of land went up and if those guys ever defaulted we would be in very good shape.

The other nice side of it is it's fairly low-priced entertainment and so the cash flows have held up decently.

We haven't had close to a default in any of that.

But it's land under those type of properties.

If you're in Orlando -- or not Orlando.

If you're in South Florida right off the I-75 across from a major shopping center and you looked, you'd see a 100-acre site.

And it would have some rides on it and it would have miniature golf, and baseball, and all the rest of it.

And it sits right in the middle of retail and 100 acre -- the land's owned by us.

We bought it at $4.00 a foot.

And now you just spread that around the country.

We own some of that up in Riverside, here in San Diego, and really throughout the country.

So very small part of the portfolio.

We tried like heck to go out and buy tons of it.

The problem is we just couldn't find enough chains that were in that business.

Just looks a little unusual, but it sounds like its actually relatively healthy.

So thank you.

My last question is I'm wondering if you had a look at the Exxon portfolio that recently transacted in the greater Washington area.

One of your peer group companies, Getty Realty, ended up buying it at an 11.4 cap rate.

Convenience stores and Exxon gas stations.

Yes, we were aware of that transaction out there and others like it, but kind of the policy is post we tend not to comment on it and then we find that we continue on the list of people that see that stuff.

Okay, very good.

Thank you.

I will (inaudible) comment what so well on it, just so you know.

Right.

Our next question comes from the line of R.J.

Milligan with Raymond James.

Please go ahead.

Good afternoon, guys.

Hey, R.J.

Just quick question.

Most of my questions have been answered.

But the -- typically you guys provide the range for the top 15 tenants in terms of coverage.

Yes, I didn't do all that, but I'll be happy to do it.

I didn't do it this quarter.

A lot of these people report annually.

Some of them report on the date of the lease of the various properties and if you just run through the third quarter it tends to be when there's the smallest amount of changes of people reporting the cash flow coverage.

I think there was only one or two, but it was relatively flat.

I think the low end was 155 and the high end kind of doesn't matter because it's so good.

It's up -- somewhere up 3.5 or so.

But it didn't really change much at all because the tenant that did report, the major one was right in the middle and the other reports we got, which had to do with individual properties didn't change the numbers that much.

Probably the best time of year when that -- when we have the best numbers there is after the first quarter.

Okay, thanks.

And one more quick question.

Can you just describe the thought process for including the additional disclosures this quarter?

Yes, really kind of go back to the start.

Previous to -- right after we went public, we continued with a policy where every year we put every tenant, every property and its address in the back of the annual report.

And then what we would do is at the end of the quarter we'd say what we bought, who the tenant was and what the cap rate was.

And we did our first conference call, this is probably 12 or 13 years ago, and when we did the world listened in and we lost our biggest tenant we were buying things from when they got under priced by a competitor who just went right in 25 bits below and we lost a big deal.

And then we lost the second biggest guy we were doing business with when they were bombarded with calls saying people would buy their properties 50 to 75 basis points below what we would do.

And if you look back then, pretty much anybody we were doing new transactions with would move into the top 10 or 15.

So we came out to all the analysts that covered us and said we're not going to disclose tenant name and we'll add all this other disclosure.

And because we'd rather be doing business and not reporting the tenant name than not doing business but having more disclosure.

And everybody was fine with it probably until about I'd say a year ago.

And as we moved into the recession we understand -- understood there were some more pressures, and we were kind of stuck on the policy.

And I will tell you that one of the analysts that's on the call and then somebody I also, who's well known in the industry, very well respected and I've known for 25 years, called me up and said, "Hey, can we have an open conversation?" And I listened to him and then we discussed it in house.

And what we also realized is now if you look at the top 15, the chance that we're doing substantial acquisitions with those guys is much lower than it used to be and it's probably going to be a name that won't get into the top 15 until we put on a lot acquisitions.

So I think the reasons for not doing it didn't have the efficacy it had in the past.

And the added disclosure, everybody would find helpful.

So that was the decision process.

Great.

Thanks, guys.

Appreciate it.

Our next question comes from the line of Todd Lukasik with Morningstar.

Please go ahead.

Hi, thanks for taking my questions.

Hi, Todd.

Hi.

Just one thing you had mentioned earlier, Paul, I think with reference to an assumption that you're using with regards to 1% decrease in occupancy.

Was that for through the rest of '09?

Or was that for fiscal year 2010?

Fiscal year 2010.

Okay great.

And then, Tom, you kind of answered this with your last answer I guess.

But I was just curious if you all would be inclined or if you had a preference to increase your exposure for future acquisitions to existing tenants?

Or if you had a preference to looking at new tenants to add to the roster?

We'll do both.

New tenants are always best because we really like the diversification.

But we're aware of kind of the concentration so when somebody gets up over 5%, then we look very carefully before we want to add very much more on, not because we don't like the tenant, just general diversification.

And we'd like to keep the industries down a bit.

So new tenants are always best, but we do have some tenants that were fairly small and you look at the top 15 and that gets you down to 2% of rents.

There are only seven tenants between 1% and 2% and then it goes down very quickly.

So there's still a pretty good list of 90 tenants or 85 tenants that are out there.

Right, okay.

And then just one last question too with regards to (inaudible) your top 15 tenants I guess.

And my guess is that it's very small, but I was wondering if you could give an average and maybe a range for your top 15 tenants for the percentage of their stores that you all own in your portfolio?

Yes, let me see if I can kind of run through it.

I'll do it quickly.

Buffets has 547 units; we have 104.

Kerasotes has 98 theaters; we own 17.

LA Fitness has 329 units; we own 18.

Pantry has 1,667 stores; we own 147.

Friendly's has 311 stores; I think we own 121.

Rite Aid has 4,825 stores; we have 42.

La Petite has 1,112 stores and we have 111.

TBC, which is the tire store chain, has 1,186 stores; we have 68.

Boston Market has 541 stores; we have 77.

KinderCare has 1,800 units; we have 85.

Couche-Tard, which is Circle K, has 5,900 stores; we have 108.

NPC International, which is Pizza Hut's largest franchisee, has 1,153 stores; we have 141.

FreedomRoads has 46 stores; we have 16.

Regal has -- do you have Regal there, Paul?

Yes, Regal has 550 stores; we have 12.

12.

And then Sports Authority has 463 units and we have 12.

Okay.

Yes, that's very helpful.

Thanks.

Yes, that's all I had.

Thanks again for taking my questions.

And Paul, we're looking forward to your participation in the Morningstar Sachs Conference next week.

Thanks, Todd.

Thanks, bye-bye.

Our next question comes from the line of Rich Moore with RBC Capital Markets.

Please go ahead.

Hi.

Good afternoon, guys.

Was the acquisition this quarter, was that a new tenant?

It was, yes.

Okay, and Tom, is there any additional stores that those guys might have beyond the three that they have?

Not at the moment, but should they, we'd be interested.

So they -- do they actually have other locations?

Or is it just those three?

No, they have other locations.

It's a chain.

Okay.

So there's a potential possibility to tap those guys again.

Yes.

Okay.

And then health and fitness you were talking about, that seems to be something that's growing and it's certainly growing in the table.

Is that -- is there any particular reason for that target?

I mean are you seeing more of that kind of product out there?

We really got on to -- we actually owned some health and fitness -- I mean going back 25, 28 years.

Had some problem with it like 22 years ago and got out of the business but continued to watch it.

And what happened is that about, oh gosh, 12, 13 years ago, these guys came up with a new model.

And now basically all of the chains that are growing have gone to it, which is like a 40,000 square foot store.

And there's an area to the left where they kind of have their sales team.

And then it's got the basics out there.

It has training, and it's got room where they can do a lot of things with it.

And they started booking their revenue differently and these newer, larger units right about that 40,000 really took off.

And we got together with LA Fitness and the vast majority of their stores didn't hit that model.

But the first few that did, the numbers were just off the chart.

So we started doing those.

And then later on the other chart -- chain started going in that area.

And it was first a change in the type of building that worked very well for them, and then I think what's happened in the last few years is demographics have helped them out and the baby boomers are kind of rediscovering that they -- they're not going to live forever.

I'm one of them, so I belong to two of these things.

But much to my chagrin, I recently learned you have to actually go to them.

You don't have to just be a member.

And you can't go to two at once I assume.

You can't.

But by the way, they are about 30,000 clubs nationwide.

I know they all don't fit this ilk, but that's the size of the industry.

And if you look from 1991 to 2009, kind of the compound annual growth rate for the industry has been close to 9% a year.

So it has been a big growth industry and continues to grow.

Okay, so you would see it as 6% that is health and fitness that you would see that growing over the next couple of years?

We wouldn't mind it at all if it went up to 6%, 7%, 8%, 9%.

We think it's a great industry and kind of hits the baby boomers moving into their -- the age they're moving into.

The issue then is trying to find the appropriate tenants.

And it isn't a huge list of chains out there, but it's a good list.

Hey, Rich.

One thing I'll add is that as Tom commented very positively on LA Fitness specifically, that's actually a perfect example of why we hesitated for so long with our tenant list.

When LA Fitness was in that, say largest tenant or in that 10% to 15% range, we were still doing a lot of business with them.

And they really weren't doing business with other (inaudible) providers at that time.

So that's just a good example of that and somebody we've been pleased to work with and really rise up in terms of our investment with them.

Okay.

Good, thanks guys.

And then -- thank you, Paul.

And then on the flip side, childcare was coming down pretty fast as a percentage.

Is that going to continue to fall like that?

Or -- it leveled off this quarter, but do you think it kind of keeps going down?

I really think it will continue to go down.

We've been in the business now -- I think we started buying it 28 years ago is when we started in the child daycare business.

It was 50% of our portfolio and now it's down to about 7.6%.

And when we found it, it was really just starting to grow.

And kind of the primary driver of the business is going back to the sixties.

The numbers were only about 20% of women of childbearing age in the United States worked.

And so there was a lot of stay at home, and that obviously has changed dramatically.

I think the last time I looked a few years ago, it was up to 60% plus of women of childbearing age worked.

And that was the primary growth of the industry.

And then you really coupled it back when we got into it that the baby boomers were having kids and so the growth was really fantastic.

Nobody else was financing the business.

There weren't any institutional players and we got involved.

We then backed off primarily as a function of it was 50% of our revenue when we went public and have worked it down.

And then the second thing that really happened is the percentage of women in the workforce kind of flattened out.

It got where it was kind of going to get, so that growth you had really went away.

And then the second thing is the baby boomers kind of moved out of childbearing age and the baby bust moved into it.

And so you really saw a moderation of the growth of their business.

As you look at the business today, I don't think the percentage of women in the childbearing age in the workforce is going to go up dramatically.

But the one thing they do have that will help them out is you now have the echo of the baby boom moving into childbearing age.

So it's a good industry, but I don't think it's going to grow much larger.

Okay, all right.

Good, thanks.

And then remind me again what the 300 non-same store stores are.

Yes, that is those stores that were vacant at any time during the comp period.

It's also those stores that went through lease rollover for a period of time and came off lease for a short period of time.

It's those properties that have been released and anything that wasn't in the comp set that had been acquired.

Okay, great.

Very good.

Thank you, guys.

Thanks, Rich.

Our next question comes from the line of Chris Lucas with Robert W.

Baird.

Please go ahead.

Good afternoon, guys.

Hi, Chris.

Just a couple of detail questions, Paul.

On the G&A guidance, it will include -- your numbers include the 1141R expenses?

Yes, it does.

Okay.

And then are you going to be providing at least a footnote to separate out that from what has been the traditional sort of accounting process so that we can get an apples-to-apples view?

Yes, we've been thinking about that because we only had a little bit of it with these couple of properties we bought in the third quarter.

But I think that's a very good suggestion.

And I don't think it's going to be a huge number, but we'll certainly break that out.

Is there a -- I mean as you think about your range of acquisitions and obviously filtering into your numbers, how should we be thinking about that relationship between acquisition volume and the ramp in G&A?

The acquisition commissions are one thing, meaning kind of what we pay, a little bit additional compensation internally relative to our acquisition [votes].

Or maybe if we have to pay maybe an outside advisor who's involved in helping us get an acquisition across the line.

But in terms of the due diligence side of it, it's not a big number.

So it depends on the property type and the number of properties we're dealing with.

But we're estimating 5,000 to 7,500, if you will for property, if that.

So it all depends on the particular situation and the work that needs to be done.

And that would include your transfer taxes or whatever would be applicable to the various regions.

Yes, for the most part yes.

You're going to have a few states where you have an anomaly on that where your transfer taxes are going to be a little higher.

Okay.

And then on the unsecured debt market, can you give us a sense as to what you're hearing in terms of what you're debt would be issued at at this point?

We actually aren't actively asking for quotes every day.

So I don't have this week's quote, if you will.

But we certainly know where the market is and if you assume the tenure's around 3.5, I think you're looking at a spread for us of somewhere certainly in the 350 to 400 over range I would hope on the tighter side of that.

So what's that, a cost of 7% to 7.5%?

Okay.

And then on the -- just on underwriting acquisitions, I guess with some of this additional detail you guys have provided today, which has been very helpful, is there a limit as to how many units you'll take from a particular credit?

I don't -- we don't have an absolute limit, but when we start owning all of it or close to all of it, then we're thoughtful about it.

However, what we have found out is that if we do have a big position then certainly if something goes sideways we can be a player in it because we control a lot of the assets.

It really speaks to more if you take a retailer and you look and say okay, this retailer has an average of, I'll just ballpark it, of the rent he pays, cash flow coverage -- EBITDA cash flow coverage at two times, it almost always is going to be a bell curve, Chris.

And to one side, he's going to have some low coverage units.

And so if you bought all of them, you'd end up with low coverage units.

So we'd just as soon try and get a small enough subset so we can stay to the other side of the bell curve and have higher cash flow coverages.

Okay.

And then my last question.

Just on the -- obviously you exceeded the bogey you wanted to hit, you talked about for several quarters in terms of the cap rate on the deals that you closed this past quarter.

What are your thoughts right now in terms of where -- what cap rates you'd be looking at doing, given the sort of healing that's gone on in the debt markets?

Well, I really think that's moderated, I think, caps a little bit.

And we'll have to see what happens there.

But my sense is of the deals that we kind of -- transactions going through the pipeline, probably the best is to say in the 9 to 10 range and then you're thinking 9.5.

But then you watch the debt markets very closely because that'll move things along.

So I'd ballpark it at 9.5.

Great.

Thanks, guys.

Appreciate it.

Thanks, Chris.

Since there are no further questions at this time, I will now turn it over to management for closing remarks.

All right.

Well, thank you very much everybody.

And we'll see you again in another 90 days and see how this all carries along in the economy.

Appreciate the support.

Ladies and gentlemen, this concludes the Realty Income third quarter 2009 earnings conference call.

You may now disconnect.

Thank you for using ACT Conferencing.