Realty Income Corp (O) 2010 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Realty Income fourth-quarter 2010 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). This conference is being recorded today Thursday, February 10, 2011.

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

Thank you Douglas. Good afternoon everyone. Welcome to our call where we will review our operations for the year and for the fourth quarter of 2010.

I have in the room with me today Gary Malino, our President and Chief Operating Officer, Paul Meurer, our Executive Vice President and CFO, John Case, our Executive Vice President and Chief Investment Officer, and Tere Miller, our Vice President of Corporate Communications.

As always, I must say, during this call, we will make certain statements that may be considered to be forward-looking statements under federal securities law. The Company's actual future results may differ significantly from matters discussed in any forward-looking statements. We will disclose in greater detail on the Company's Form 10-K the factors that may cause such differences.

As we usually do, Paul will start with an overview of the numbers.

Thanks Tom. As usual, let me give a few highlights of our financial statements and results for the quarter and for the year, starting with the income statement.

Total revenue increased 13.4% to $92.2 million this quarter, versus $81.3 million during the fourth quarter of last year. This increase in revenue reflected a significant amount of new acquisitions over the past year as well as some positive same-store rent increases for the quarterly period of 1%.

On the expense side, depreciation and amortization expense increased by $2.35 million in the comparative quarterly period, naturally as depreciation expense increased as our property portfolio continues to grow. Interest expense increased by approximately $3.75 million. This increase was due to the $250 million of senior notes due 2021 which we issued in June of last year. On a related note, our coverage ratios remain strong with interest coverage at 3.3 times and fixed charge coverage at 2.7 times.

General and administrative, or G&A, expenses in the fourth quarter were $5.785 million, up from last year on a comparative quarterly basis but down about $400,000 from the third quarter of this year. As we've mentioned over the past year, the increase in G&A this year is due largely to recent hiring in our acquisition and research department. We had reduced G&A in each of 2008 and 2009. During 2010, our G&A expense increased as our acquisition activity increased, and then we invested some more in new personnel for future growth. Our current projection for G&A for next year, 2011, is approximately $28.5 million, which will still represent only about 7% to 7.5% of total revenue.

Property expenses were $1.925 million for the quarter. These expenses are primarily associated with the taxes, maintenance and insurance expenses which we are responsible for on properties available for lease. Property expenses increased about 10% this year, but our current estimate for 2011 is much lower at approximately $6.6 million, or back to prior level.

Income taxes consist of income taxes paid to various states by the Company, and they were just over $500,000 during the quarter.

Income from discontinued operations for the quarter totaled just under $4.9 million. Real estate acquired for resale refers to the operations of Crest Net Lease, our subsidiary that acquires and resells properties. Crest did not acquire or sell any properties in the quarter and overall contributed income from discontinued operations of $229,000.

As we mentioned in the press release, we did move the three remaining Crest properties held for sale to held for investment, as we've had strong leasing interest on these three properties, which we plan to pursue rather than selling these properties in the near term. As part of this move, we did record total impairment of $807,000 in aggregate on these properties.

Real estate held for investment refers to property sales by Realty Income from our existing core portfolio. We sold nine properties during the quarter, resulting overall in income of approximately $4.6 million. These property sales gains are not included in our AFFO or in our FFO.

Preferred stock cash dividends remained at $6.1 million for the quarter, and net income available to common stockholders increased to approximately $31.8 million for the quarter.

Funds from operations, or FFO, increased 8.5% to $52.5 million for the quarter. FFO per share was $0.47 for the quarter and $1.83 for the year.

Adjusted funds from operations, or AFFO, or the actual cash that we have available for distribution as dividends was higher at $0.48 per share for the quarter and $1.86 for the year. Our AFFO is usually higher than our FFO because our capital expenditures are fairly low and we have minimal straight-line rent currently in our portfolio.

We increased our cash monthly dividend again this quarter. We've increased the dividend 53 consecutive quarters and 60 times overall since we went public over 16 years ago. Our dividend payout ratio for the quarter was 91% of our FFO and about 90% of our actual cash, or AFFO.

Turning to the balance sheet, we've continued to maintain a conservative and safe capital structure. During 2010, we were able to permanently finance over $700 million of new acquisitions with $450 million of new common equity and $250 million of 10.5 year bonds at a 5.75% coupon.

Our current debt to total market capitalization is only 26%, and our preferred stock outstanding represents just 5.5% of our capital structure. We had $18 million of cash on hand at December 31, and we had zero borrowings on our new $425 million credit facility. This facility also has an additional $200 million accordion expansion feature. The initial term of it runs until March 2014 plus two one-year extension options thereafter. We have no debt maturities until 2013.

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

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

Thanks Paul. What I'll do is run through each facet of the business and then talk about how we see 2011 shaping up. Let me start with the portfolio.

The portfolio continued to perform very well during the quarter, and for the year, I think operations continued to improve pretty much across the portfolio. I believe that's mostly true for not only us and the properties, but most of the tenants that are in the portfolio. We did not have any significant tenant issues that arose during the quarter, and we have nothing on our radar currently relative to tenant issues. Seems to be a fairly stable portfolio that's increasing modestly as we move along.

At the end of the quarter, our largest 15 tenants accounted for a little over 54% of our revenue. That's down about 40 basis points from what it was in the previous quarter. The average cash flow coverage for those tenants is about 2.4 times, so very healthy overall and all of them have positive cash flow coverage.

Relative to occupancy, we ended the quarter 96.6% occupancy, had 84 properties available for lease out of the 2496 properties. That's up 20 basis points from the third quarter and down about 20 basis points versus the same period a year ago. During the quarter, we had 11 new vacancies. We leased or sold 11 properties, and since we added 163 properties to the portfolio, that's how you get to a 20 basis point increase to 96.6% occupancy. I think, going forward, looking at the first quarter, I think we'll see small but probably continued improvement in occupancy, and I would say flat to up another 10 or 20 basis points would be my best guess as of now, but very healthy.

Same-store rents on the core portfolio increased 1% during the fourth quarter as compared to 0.3% in the third quarter and 0.1% in the second. So the run rate continues to increase, and I think it will continue to do so over the next quarter or so.

To break down really where the same-store rents increases came from, we have three of our industries plus kind of the other category that had declining same-store rents. Restaurants, entertainment, and consumer electronics were most of it, but the declines in the four areas were only about $170,000 of rent. Three of the industries we are in had flat same-store rents, and then 23 saw some type of same-store rent increases. About half of that came from theaters during the quarter, and then some decent increases on our childcare, convenience stores and auto service portfolio, the balance of it pretty small. The 23 industries together, we had increases of about $938,000, and that gave us the net gain of $768,000, which is the 1% increase in same-store rent.

We've been talking for a couple of quarters as seeing the portfolio improve (inaudible) summer might be the bottom, absent the double dip in the economy. We continue to think that and continue to think we'll see modest increases, as we move into 2011, in the operation of the portfolio.

Relative to diversification, as I mentioned a second ago, we are at 2496 properties. That's up 154 properties from last quarter, 32 retail industries, 122 multiple unit tenants, and it's still in the same 49 states.

Relative to industry exposure, there's been a little movement during the quarter. Restaurants continue to come down, and that's now under 20%. But looking at the first quarter, the run rate is probably closer to 18%, and it is likely, in the first quarter, to become our second-largest industry. Convenience stores are at about 17% but given the recent SuperAmerica acquisition, that should be up to about a 20% run rate in the first quarter. After those two fairly large industries, you drop down to theaters, which is about 8.6%, so in pretty good shape relative to diversification we continue to be.

Our largest tenant at 5.9% as you can see in the releases is Diageo, second is AMC at 5.5%, and as I mentioned earlier, the top 15 are 54.4% revenue. To give you an idea of how they really declined as percentage of the revenue, when you get to the 15th largest tenant, you can see it's about 2.2% revenue, past our 27th largest tenant, the balance of the 95 other tenants are each less than 1% of rent, so we remain fairly well diversified.

From a geographic standpoint, California is our largest state as 10.8%. About half of that is Diageo. They really book their revenue across the country, so it's a little less, I think, economic impact of a 10.8% exposure to California. Then Texas at 8.8%, Florida at 7.5%. From the acquisitions we made and properties that we released, the average remaining lease length on the portfolio remains very healthy at 11.4 years. I think that's up a bit from last quarter. So I think overall, in the portfolio, it remains quite healthy, and, again, no tenant issues have come to our attention and we feel fairly positive about the portfolio.

Moving on to property acquisitions, obviously during the fourth quarter, we were very active and acquired 163 properties for just under $411 million. Cap rates on the purchases were pretty good at 8.1%, average lease terms of just over 15 years.

From a diversification standpoint, the 163 properties were leased to 16 different tenants in 10 different industries, the largest though, as we noted in the release, was the $248 million of that that was the SuperAmerica transaction that represented about 135 properties. For the year, that got us to 186 properties acquired for 713 million. Average lease yield was 7.9%, average lease term 15.7%. And good diversification, 186 properties leased to 20 different tenants in 11 different industries. The $713 million I think is the second-largest total amount of acquisitions in any one year for us, the largest for the core portfolio and obviously very pleased with the results as I think these acquisitions will really help us in driving our FFO growth here in 2011.

We've said for a long time, for those of you that have followed us, that when we are acquiring, generally we will acquire kind of $10 million, $15 million, $30 million each quarter just by being out there in the business, and then that will get us to $100 million or so in acquisitions. Then after that, it's really a function of how many larger-type acquisitions we work on in our investment committee. Then if we end up doing none of them, two or three of them, and that's really going to drive the acquisition numbers, so it can be fairly lumpy year in and year out, and also certainly quarter to quarter. This year we did have a couple of those that came through the larger transaction. That's the reason for having a substantial year for acquiring properties.

I mentioned (technical difficulty) a second ago, and I think this is a great example. For 2010, we did $27.5 million in acquisitions in the first quarter, $261 million in the second quarter, only $12 million in the third quarter, and then $410 million in the fourth. That type of movement is fairly typical when we are relying on doing some larger transactions.

Usually in this call, as I do every year, after the completion of the year, is to try and give you some idea of transaction flow that we went through. There's quite a few numbers in here. If you miss one or two, hopefully you can pick them up from a copy of the transcript. But if you look at 2010, there was $5 billion to $5.5 billion that kind of came through the door. Not all of that actually ends up really getting underwritten or in committee. But relative to what went into the investment committee, we had 70 different transactions the committee worked on this year. They represented about 1500 properties. The offer value of those was just over $3 billion, and the average cap rate offered was about 8.8% with a range of 7.5% cap up to about a 10.8% cap. So 70 transactions, 1500 properties, about $3 billion that went through committee.

We ended up buying properties in 11 different transactions of some size. The 186 properties obviously I talked about earlier and $714 million. Cap rates were 7.9%, so if you take the $3 billion that went through the committee and the $714 million we acquired, that's buying about 23.5% of what we looked at in investment committee.

To put those numbers in perspective, I've been keeping those for nine years now, since 2002. If you look back over the nine years and look at the value of properties that went through the committee or the serious deal flow, it averaged about $2.9 billion a year. That's a low of just over $1 billion up to a high of about $5 billion. We did $3 billion this year, so pretty much average for the last nine years. The average we bought out of that over the last nine years is about $385 million a year, but that's varied from $58 million at the low and a high of $770 million versus $714 million this year. If you run those percentages, the average over the last nine years is acquiring about 13% of what went through committee with a low in one year of 4% and a high of 26%, and about 23.5% this year.

Cap rates, the average has been about 9% over the last nine years, a low of 7.9%, high of 10.4%, and 7.9% was this year. Again, much more comes in the door that ends up in the investment committee and the flow is about half ends up going to committee of what we take a quick look at and then buy anywhere from 4% to 25% of that. This year, because of a couple of large transactions, it was 23.5%.

If you look at kind of the transaction flow for 2010, it's down from a few years ago but I think average for the last nine, and I think just a pretty good flow given the recovery in the economy. We're starting to see some things open up relative to seeing transactions.

Going back on cap rates for a minute, they've obviously come down over the last nine years or so as interest rates have declined and I think as also kind of net lease real estate has become a little more mainstream from an investor standpoint. But it's interesting to note that the spread of cap rates over the 10-year treasury for us, if you look back over the last really 16 years, it's averaged about 480 basis points that cap rates were over the 10-year treasury. Looking back on the 10-year, we did some averaging, averaged about 3.11% this year. Our cap rates ended up at 7.91%, and so strangely enough, this year it was about a 480 basis point spread over the 10-year on cap rates.

I think the main thing relative to our cap rates this year for us was moving up the credit curve for the year with our acquisitions. Unlike in previous years, over half of the acquisitions we made this year were with investment-grade rated tenants. That probably took 50 to 60 basis points off our yields for the year, but given we were able to maintain very good spreads over our cost of capital, we're pretty pleased with that.

If you look at the acquisitions market now kind of as we see it, we continue to see a very good flow of acquisition opportunities to work on. Transaction flow to look at is certainly above where it was a year ago and pretty steady just coming through the door.

I'd really say that the opportunity -- the volume of opportunities accelerated in the second half of the year, and looking here in the first quarter, it is really staying at about that rate. So there's a fair amount that we are underwriting, we're fairly active in committee, and it will be interesting to see what actually gets through and what we end up closing on. But we have a lot to look at.

From an industry standpoint in terms of transaction flow, as always, we are seeing a lot of transactions in the restaurant industry, in the convenience store industry. But after kind of those two big ones, what the theme seems to be is that there are a number of sellers out there that are looking at cap rates and interest rates and kind of looking into the future and feeling this might be a good time to go to market, so I think that's why things have been accelerating.

Then as you've probably noted, there's been some pick up in the M&A environment. That generally can bring some transactions out of the woodwork that we can look at.

Cap rates continue to decline I'd say modestly, still given the demand for yield in the world and the number of people out there with money that are looking to buy. I think we generally look for cap rates to be around 8% right now for good transactions. I think that's pretty much like last quarter, depending on the credit of the tenant. Again, last year, we were at 7.91% average cap rates. As I mentioned a minute ago, that was influenced by doing a lot more moving up the credit curve with investment-grade tenants. So if we're thinking around 8% or so today, it's really not cap rates we think moving up. It is just a function of not being sure how much we will be working up the credit curve this year. So I'd say modestly lower cap rates out in the marketplace which will probably hang somewhere around 8% or so.

Relative to spreads for us, if you look at the historical spreads over our nominal cost of equity, which is basically taking a forward FFO yield and grossing it up for issuance purposes, I went back and looked over the last 16 years or so. Generally, the average cap rate we've gotten on acquisitions has been about 105 basis points over that grossed up kind of FFO yield number. Right now, it's closer to 175 to 200 basis points, so obviously a pretty good environment to take advantage of if we can find the transactions we like. We are optimistic about having a decent year in acquisitions, but again it will be what happens relative to some of the larger transactions we get to look at.

For our guidance this year, obviously with the growth in the acquisitions last year, that's going to start growing -- has started to grow the topline which you can see in the numbers. Given the fourth-quarter activity, I think that will continue and be very additive this year.

You see the guidance is $1.96 to $2.01. That's 7% to 10% FFO growth. In that number, we are assuming only about $250 million in acquisitions for the year at 8%, and also assuming that the portfolio continues to be very stable and grow just a bit. Then that should allow us to continue to grow the dividend this year, and at the same time drop our payout ratio a fair amount. Then if the acquisition numbers were to get bigger than $250 million, that will give us some more flexibility relative to additional dividend increases or lowering the payout ratio. So we'll see how that unfolds.

As Paul mentioned, the balance sheet is in good shape. Access to capital is great right now. There is no balance on our $425 million line and we have some cash on hand. With no debt coming due and no mortgages, I think in pretty good shape from a capital and balance sheet standpoint to acquire this year.

I'll just conclude by saying good stability in the portfolio with modest improvement and a great year for acquisitions which will help us for FFO this year. We'll see what we can get done relative to the acquisition environment right now.

With that, I'll open it up for questions if Douglas will come back and say hi to us.

(Operator Instructions). Lindsay Schroll, Bank of America.

Can you discuss some of the reasons for increasing the capacity on the line of credit?

Yes, that was -- first we wanted to redo the line of credit early just because we thought it was a good time and wanted the capacity, but as we got into the second half of the year and started seeing the volume of opportunities increase and some of them being a little larger, we thought it prudent, given the size of the Diageo earlier in the year and then we are already working on the SuperAmerica and knew that if something else came around, it would be very couple to have more capacity. So the $425 million was a decent guess of what that size should be. Then the $200 million accordion on it I think gives us good flexibility to be working on a couple of things if we needed to do it and be able to close them and not be forced into the marketplace or to go out and do a term loan very quickly.

Great. What are you seeing in terms of large portfolios in the marketplace?

As I mentioned there is more and more. I think, as you see more and more M&A activity, that's really what it's going to key off of. There were probably three, four, or five kind of in the second half of the year really moving later into the year that we were looking at, of which we were able to do some. That volume is similar today. They range in size anywhere from $50 million to $300 million or $400 million. Typically, if you get 10 of those through the door, we will end up closing a couple of them, but it's hard to see how much. But it's fairly active and M&A driven. Then just as I said earlier, a few people who have some good-size portfolios they've accumulated over the years, whether a developer or an institutional holder. If they haven't gone to market in the last few years because of the state of the economy and not a lot of people investing, I think they're seeing it open up and thinking maybe it's a good time to go.

Last question -- you mentioned I think that triple net lease investments are becoming more mainstream from an investor standpoint. So do you think the level of competition is increasing, sort of remaining the same? How do you see that playing out in 2011?

It's very competitive out there. I wouldn't want to say it any other way. There's a lot of capital floating around trying to find a home. I think, as long as I've been in this business, there's always been ourselves and maybe one other people out actively buying, and then there is usually, every few years, a marginal buyer that needs to put capital out, and they are out there being very aggressive. I can't think of a time when that wasn't the case, and it's the case today.

Then I think you're seeing more of some institutional players that might not have been doing triple net that are today. So there's a lot of capital out looking at it. Each of these companies have different characteristics. So I think it will be very competitive this year, but I think we will be able to hold our own, given our cost of capital.

Great, thank you.

Jeffrey Donnelly, Wells Fargo.

Good afternoon guys. Tom, how do you think net lease -- I guess initially [you guys will] respond to the prospect of rising interest rates over the next few years. Do you think they will resist some degree of increases or do you think it is going to be sort of a one-for-one rise?

Yes, that's a great question. Traditionally, when interest rates moved to some degree one way or the other, there was generally a pretty good lag before the property started moving cap rates. That's whether they were going up or down. I think that would be the case, but if you look maybe six months to 12 months beyond interest rates really starting to move, you'll see cap rates starting to move also. But having been through this now a number of times, if you saw a 100 basis point increase in interest rates, I think you will see cap rates go up 10 or 20 basis points for six months and then start catching up. I think they would eventually.

I'm curious how do you think about your own cost of capital in that scenario? Because right now, you sort of enjoy it fairly widespread versus where private market initial yields are on net lease. Have you looked at sort of how (inaudible) incomes, maybe the average cost of capital responds to changing interest rates?

Yes. That's an equation with multiple inputs and outputs, but it's interesting. If that increase in interest rate is due to higher inflation, in anticipation of inflation, as you know, capital flow is adjusted out and real estate is one of the places they go to, so you could see an environment where maybe debt costs might be rising but on the equity side, for a while at least, you might get the benefit of some additional flow.

But overall, when I look at it, I thank the cost of capital would probably go up and would probably go up a little faster than cap rates would. That would be margins would come in or spreads would come in. I mentioned today, [over] our equity cost of capital, we are at about 175 to 200 basis point spread. I think that is a good scenario because if you look at the last 16 years, it's only been 105 basis points. So taking the opportunity now to acquire, if you can find the right things, this is the time to do it. But there is enough spread out there right now that you could see the spread close between our cost of capital and our cap rates, and it would still be a pretty good time to acquire for a while.

The other thing is that, on the expense side, obviously we have no variable rate debt, so we would not get hurt from the standpoint of any current costs on the debt rising. That might not be the case for others. Then our property expenses are naturally going to not be as effective because we are triple net. So in terms of the existing portfolio and our existing cost structure, a rising inflationary environment does not hurt us.

Then as Tom mentioned, if debt rates go up a little bit, we think the sale leaseback product could be more competitive as long as they don't rise dramatically. We like the debt markets to be alive and well for our tenants and for folks out there doing transactions.

One other thing too is, given spreads got as wide as they did this year, we really -- it wasn't -- I wouldn't say it was a campaign, but I would say one of the things we were looking at is saying this is a good chance to move up the credit curve, add some diversity to the portfolio relative to some investment grade tenants and given the large spread, still have good spreads to [go to] earnings.

If you saw interest -- cost of capital going up, it'd probably cause us to do less of that and return more to our traditional things. So, we may be able to maintain the spreads a little bit for a while, but ultimately if interest rates go up, cap rates will lag it, and I think everybody participates in that.

That's helpful. Just I guess one last question is after you did the Diageo Vineyard deal last year, you talked a little bit about being more open to I guess I'd call it hard assets, where I guess I'd characterize them as alternative or maybe just not detail oriented, but where you felt like the EBITDA from those assets was inseparable from the property's [operations] itself, like farmland or factories and vineyards, and things of the such.

Have you guys made any headway on that, [stuff] like those? Do you have a target for what I guess I'd just maybe call non-retail assets in your portfolio?

We wouldn't mind -- and I really look at this over a period of 10 years -- kind of widening out the net [EBIT] in the portfolio. So very slowly we start looking at some other areas.

Let me kind of go on just for a minute because it's interesting. We had six industries when we went public. We are in 32 today. I'd like 40 or 50 if I could, because the realty game is allocating capital where people need it and as time goes on, different industries different -- need more or less money. While retail will continue to be huge, I think the consumer may be a little less positive in future years than they were in the past, given they levered up their balance sheets pretty well. There was a huge amount of new store growth and we just see a more moderate environment kind of looking into the future. Given that net leases become a little more mainstream, it probably makes sense to widen it out if you can find investments in other areas that have very similar characteristics to support your underwriting.

So I think really for it, if you look at what we have done traditionally, we are looking for tenants that have multiple cash flows and retailers with multiple stores. If you look at Diageo, that's somebody with 65 consumer brands in 105 countries, so the thing we are owning is not really relying on that's it, that's the one cash flow stream they have.

If you look in other areas, if they are not large owners of real estate as a very critical part of their business, it probably doesn't make sense. But when you get -- the key for us is that the real estate is absolutely necessary in generating the revenue and EBITDA and then trying to tie that EBITDA to the properties as you mentioned. Long-term lease, same characteristics, [triple-D] net lease in a spread.

What we've done in retail over the years, and I think the way we looked at Diageo too, is any time there is an issue in credit underwriting or you know the property is really important for creating their EBITDA but it's hard to support exactly how much EBITDA that property does, then you either move up the credit curve. If you recall, years ago when we did the Regal transaction, doing a structured transaction, or something where you are maybe only buying land with a lot of assets on top of it where you're relying on residual value, which we have done for about 10 years now in kind of the entertainment area. So that's kind of how we look at it. I think we've kind of slowly moved into new areas in the past. I'd like to widen it, but I don't think it's going to be some massive campaign and now we've changed where -- how we are investing the capital out there. But if 10 years from now I woke up and there was 10% or 20% or 30% of the assets that were really outside of retail but still had all those characteristics in triple net lease, I think I'd be pretty happy about it. But as always, I think it's going to be a -- we do a lot of research, crawl for a while, then walk for a while, and if it works, then you run a little harder.

But more likely kind of outside I guess what I would call the consumer area, like in more of a corporate -- again, like vineyards or maybe farmland or -- or like [energy] power plants, I don't know. I'm just thinking aloud here.

We started thinking about this about four or five years ago and kind of the first thing is if you look at the company, we've kind of follow the Baby Boomers over the years. So you'd sit around and just off the top of your head you go, okay, how old is this large group of demographics? What's in the future? Adult day care, drugstores, health and fitness, health food, medical equipment, that type of thing you start thinking. But then it really happens slower than that. So while I think it will happen, I don't think it's going to be anything way out there. we started looking at wine four or five years ago, did the research, didn't think we would get there, and then Diageo came up. We also did some additional Diageo in the fourth quarter, about $30 million worth, but beyond that, I don't know (inaudible) we do in wine, so we really didn't have one target. I think it's just being open to do things that come across our desk that fit the characteristic.

I'm sure you'd like to do due diligence on the golf courses then, So --

I'd love to do the due diligence but I doubt I'd like to invest.

Thank you guys.

Gregory Schweitzer, Citigroup.

I had a couple questions on the SuperAmerica deal. Perhaps you could walk us through how you got comfortable [and underwrote] any potential environment for concerns that went along with the (inaudible) stores, in SuperAmerica specifically?

Yes, as you know, we've been in that industry for nine or ten years, and before we did that about 17% of revenue and have done a lot of transactions. It really starts for us is the risk in that business changed a fair amount a number of years ago when everybody in America that operates a gas station or convenience store that sold gas had to replace their tanks and put in new double-walled tanks with alarms. So I think that game changed a little bit. Then secondarily, a lot of studying over time to see how much environmental liability really comes out of gas stations and convenience stores, which is a lot less than you would think.

The next thing then is working with a large enough entity that is going to basically take on that liability for you, which all of the tenants do. They're first responsible for it rather than us, so as long as you have a viable tenant, it's not you. You then go out and do Phase Is, you look at the history, and then very often what we do is require the tenant, most of the time, all of the time, to have environmental insurance above and beyond just indemnifying us.

We also look very carefully at each state that we invest in and what's their situation. Do they have a fund? Who would have access to it under what circumstances? Then we carry our own liability, environmental liability insurance, which we've never had to use. So if you work through all of that and you look at the history of convenience stores, particularly when they're leased to a larger entity, there has been -- we really haven't had evidence of environmental liability in this industry. But that's kind of how you got there.

In this particular case, this obviously was a spinoff of a division of Marathon Oil, which included a refinery and a pipeline and very large support services in 160-plus convenience stores. So a large public company like that, particularly in these days of Sarb-Ox, has a lot of controls. So if you walk through all of that, we get pretty comfortable. I don't know I left anything out, Paul.

That covers it.

Thanks. Just [apart] from the location, do you have any insight on what differentiated the SuperAmerica C-stores from (inaudible) Speedway brand that Marathon ended up keeping?

Yes, I think it was more a geographic movement tied to the pipeline in the other operations. And over -- as you've seen in recent years, there was kind of a trend from the major oils moving out of retail and focusing on the other end of their operation. But I really don't think there was a lot. If you look at these convenience stores, they are the poster child for what we look for in the industry. They are, first of all, over an acre of land, and as you know, you on both the convenience store and gas station so you can amortize the cash flows over one rent. These average 1.14 acres.

The second thing in that business is you see a lot of convenience stores that may be 800 or 1000 square feet, but until you get up closer to 2000 square feet, it's hard to really merchandise those stores effectively. In the industry, about two-thirds, about a third of your revenue and two-thirds of your profit though comes from the convenience store. So to the extent you can get larger stores, they can be effectively merchandise, and these average 3500 square feet, which were on the large side of what we bought, the 6.5 multi-pump dispensers and the card readers and everything you would see.

The other thing though with these is they are not new stores. The average age is about 20 years old, which is surprising, given the size, that type of size was not typical back then. All of them have basically been reengineered and a lot of money put into them over the last seven, eight years.

So for us, if you look at Speedway, they are similar large stores, and those are kind of the most valuable I think because of the revenue stream that can be thrown off from a larger store that can be merchandised are what people look for in the industry. And these had been. I think it was more geographic.

This one was unusual for us. Typically when we do a portfolio, it's spread out around a lot of states. In this one, there was I think 160 convenience stores that came with it, of which we bought 135. The vast majority are in one metropolitan area, which is Minneapolis. So if you look at this size of store concentrated in a metropolitan area -- and we were able to get them at about $[1.10 million for copy]. We felt very strongly that they were good stores. So I don't think it was a choice of these versus Speedway for them. But I don't know. You'd have to ask them.

Then just one more on that line. What are the gas gallon sold metrics versus the national average?

They are higher. But as you know, we really can't report our tenants' operating numbers, nor their financial. They get to do that. But they were substantially higher, which isn't -- which is something that we really look at, and the same with merchandise. I think it was a very good purchase for TPG and ACON.

Dustin Pizzo, UBS.

Tom, can you talk about, as you're looking at acquisitions today and in 2011, what you currently have, either under contract or under LOI?

I will [respectfully report] what we bought at the end of the quarter. The exception we do to that is if we have something big that we have tied up and we know it's going to close, and we are not in that situation today. So like last year, when you looked at $27.260 million, $12.4 million, it's very, very difficult for us to know quarter to quarter. But we don't report kind of what we have under contract and [what's] tied up, because how you define that really drives what those numbers are. Until you absolutely have it under contract in your heart and you've completed your due diligence, we don't know if we'll close.

Okay. Then in the guidance, the way the acquisitions are factored in there, are you assuming that they ratably occur throughout the year?

Yes. , Generally what we do is assume that the majority will close at the end of the quarter, as a lot of times they do. So we've just divied it up pretty much at the end of the four quarters throughout the year.

That's helpful. Thank you.

Tayo Okusanya, Jefferies & Company.

Good afternoon. Just a quick clarification. You mentioned that the rent coverage ratio in the portfolio right now is 2.4 times.

Yes.

That number, if I remember correctly, used to be as high as 2.7, correct?

Yes. Actually, that's a very good memory. It was, about three-four years ago, 2.77 I believe (multiple speakers) the number in '06 and then came off and was lower a couple of years ago. I think it was like 2.47 a couple of quarters ago, but 2.42 is what it came in this time.

Could you talk a little bit about which (inaudible) industries are driving that average a little bit lower?

Now you're really going to challenge me, Tayo, because while I have that stuff -- trying to remember off the top of the head. It is interesting. During the recession, I will tell you that it was -- if you recall, we talked a lot about the RV business and our tenant in that industry. What's industry interesting, they are now in the upper half in cash flow coverage, and RV sales were up 48%. So I know that one flip-flopped big the other way.

I think restaurant continues to be challenged. That's kind of the industry that I think hasn't gotten a lot of traction. The fast food guys have done pretty well, but outside of that, restaurant is -- while they've made improvements and they have rationalized their business and cut their costs, and while a lot of them have a chance now to fix their balance sheet, their business in no way has come roaring back. So I think those are the ones that, if you look across, are probably the weakest. After that, everyone is looking pretty good.

Just because restaurants are such a big part of your overall portfolio, it really kind of skews the mix.

Yes, about 17%. I was going to give the range. I mean the cash flow coverages are somewhere around 1.5, and then go up into the high 3s by tenant. So, that's kind of the range.

Got it. That's helpful. Then just kind of given all the, [one], competition you'd mentioned increasing the available cash and the margins, are you somewhat surprised that 1031 transactions have not started coming back?

That's a very interesting question. The answer is I don't know if I'm surprised, but it's a good observation that the money that's floating around is in institutional hands. I think it kind of speaks to the bifurcation that everybody is noticing in the economy, that it's very much a have, have not society, and those institutions that are large and get access to capital out there, and those that are smaller really struggle. But given that's the case, it's kind of the same in our markets. The 1031s are kind of soft, but there's a number of institutional players with money.

Got it. That's helpful. Thank you very much.

Rich Moore, RBC Capital Markets.

Good afternoon. Given all of the capital, Tom, that you were talking about that is out there and then these other good ideas that you'd like to pursue for other sectors, other concepts, what do you think about selling some of your assets at a bigger pace than what you've done historically?

It's interesting as we walk through there. If you get a let's say an acquisition pipeline that's very, very, very large, then you can do it and it can be somewhat accretive. We haven't really had the opportunity to do that too much in the past. It's been modest sales. As we go forward looking at the portfolio, I don't think it's anything in the cards for this year, but it is something that we are really thinking about relative to looking at various industries and lease durations, and know what opportunities are out there. So it's something that's hanging in the back of our mind, but nothing that we see coming really for this year, unless all of a sudden we see a huge amount of acquisitions coming in. Then I think you could make some major moves in the portfolio without upsetting the revenue stream too much.

I see, but even to take the opportunity to go up the credit curve a bit, it would, even with a little bit of loss of FFO or capital or of cash flow, it wouldn't interest you to get rid of some of these?

It would interest me, but after very happily getting through the recession with stable FFO, I'd like to grow it a bit, get the payout ratio down, raise the dividends a bit. That will give us the flexibility to start doing that.

Got you. Very good. Then this is the time of year when retailers seem to have their difficulties, if they are going to have difficulties. How are you guys thinking about any troubled tenant exposure?

Yes, it's interesting. You're absolutely right. They go through the holidays. Of course, most of our portfolio is kind of service oriented, not traditional retail, the guys that are in the malls and really booking the huge Christmas sales. So I think we are less exposed to that. But we have seen that January/February/March is the time, but there's really almost nothing going on in the portfolio. I did a scan of the major tenants out there, and we have absolutely nothing on our radar screen right now for this year, which is one of the reasons we're fairly positive about things.

Good, thanks. Then the last thing I had was there's obviously been some demand from -- demand increase from the big box type retailers and others out there. I'm wondering how you're coming on the 84 visas? Obviously, you did some this quarter and came back to 84. But what do you think going forward for the ones you have that are vacant that you're trying to lease out?

We've actually made some good progress that doesn't show in the numbers because you had 11 in an 11 out. But one of the things that's happened is you're right. There is some demand on the larger size and so some of the releases that we are able to do was on the larger space. As you know, we calculate our vacancy by taking the number vacant, 84, and divided it by the number of properties, 2496. That gets you to the number. What we also track internally of the ones that are vacant is what percentage of the revenue they represented before they went dark. Generally they match up pretty evenly, but right now it's 3.4% just on a numerical from a vacancy standpoint, but it's only 2.7% on a revenue side. So we actually did -- what we did move was some larger space, which helped us out. The numbers are actually a little better than they look.

Okay, so the remaining (inaudible) smaller assets in general?

Yes, they are. There's a lot of childcare hanging out in there in those numbers that we are working on.

Great. I got you. Thanks guys.

[Tom Mukasic], Morningstar.

Good afternoon. Just Paul quickly first, I don't know you've got the lease termination fees for the quarter?

Lease termination fees for the quarter? I will find it while we speak.

Then the other question I had kind of followed on with the interest rate question you guys fielded earlier. I'm just wondering what your expectations are with regard to inflation. If you want to hit on any of the key points about how inflation impacts the portfolio performance and whether or not expectations of a rising inflation rate would change how you think about permanent capital between debt preferred and common?

Sure. I'll let Paul answer that question you (inaudible) and then I'll come back (multiple speakers)

Yes, $350,000 for the quarter.

Okay, that's quite a bit lower than the run rate prior to that, right?

Yes. Let's see. Comparative quarter a year ago, that was about $80,000, but on a year-to-date basis, that's actually down. I mean we had just under $500,000 this year for the year, whereas we had over $700,000 in '09. When there was stress for some tenants, there was obviously negotiations going on where they wanted to exit a lease early, or that sort of thing. We are not having as many of those discussions today.

Relative to kind of inflation and the impact and our thinking and capital structure and what we do, it's interesting. I thought we are going to have a major recession for about three years before we had one. So I think there could be some inflation in the offering, but I've learned not to try and guess what it is, just that we are more likely now to have it in the future perhaps than in the past, given monetary policy out there and what you're seeing in commodities and some other areas. But it does.

One of the things that we'd like to do is really relates more to the impact that inflation might have on interest rates and higher interest rates, given how low we are, and after 30 years of declining interest rates trying to look forward long-term and assume that we are more likely than not going to see increasing interest rates, given how low things are. So, we had more of a prejudice even than we had in the past for utilizing equity, although I'm sure at some point we use debt. If you look in the last year or so, our debt on the balance sheet has started to climb. Debt to market cap is like 26-something. We'd like to bring that down further because I think, in the next year or two or three, look, everything is just fine. But if you start look at even a modestly levered balance sheet like ours and refinancing three, four, five years down the road at higher interest rates, you can have some FFO pulled out of the numbers. To the extent you continue to add debt on, that could be sizable. So I think it really leads us towards trying to keep a very modest amount of leverage on the books looking over the next five, six, seven years, and then kind of being tactical in the short term.

Relative to the revenue side, in our leases, one of the things that has happened over the last 25 years is, given there was a big bout of inflation early in our business, is retailers really got away from allowing the landlords to have a lot of inflation increases in the leases. While they are talked about a lot, most triple net leases don't have a lot of them. We have built into ours that we don't straight-line, as you know, anywhere 1% to 2%, 2%-plus. When you get much beyond that and you look at inflation, it's hard to adjust. That's been a major program we've been on for a couple of years, but given the size of the portfolio and how difficult it is in acquisitions, it's very hard to move that number. But looking back 2.5 years ago, only about 6% of our leases really adjusted well for inflation either through being a flat percent of sales or a CPI. We now have that up to about 18%, but it's very slow going trying to move that needle. So if you had higher inflation, higher interest rates, I think we would adjust decently on the revenue side. But on the expense side, we want to make sure it doesn't hurt us, so it probably leads us to lean more towards equity than debt.

In thinking about common versus preferred, if you think there's going to be an inflationary environment, would you have a preference for preferred equity?

We've used preferred. If you look at the differential in price today, it's substantial. If you do kind of that FFO, forward FFO yield grossed up for issuance of equity, you get a little over 6% today, not much. Paul, if you were issuing prepared --

We could do something inside of 7%, but from an all-in cost basis, you are around 7%.

Yes, so you give up 100 basis points today, but you kind of fix it. It could be attractive. We'd have to watch it, but I don't think preferred will ever be a huge part of the capital structure. I think we kind of think equity first, preferred second, and then debt when tactically it makes sense for us, like Diageo when it was a fairly large acquisition in a new area and we weren't sure quite what the impact to the marketplace was going to be. And we were able to finance first with debt and it turns out the market seemed to be happy with what we bought, came back with equity. That's kind of like we want to use debt, but we'd use both.

Okay. Thanks for taking my questions. Nice job on the year guys.

This does conclude Realty Income's question-and-answer session. I'd like to turn the conference back over to management for closing remarks.

Thank you everybody for taking the time today. We'll talk to you soon at one of the meetings out there, or hopefully at the next call. Thank you very much. Thank you, Doug.

Thank you sir. Ladies and gentlemen, that does conclude our conference for today. I'd like to thank you for your participation. You may now disconnect.