Realty Income Corp (O) 2011 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Realty Income first quarter 2011 earnings conference call. (Operator Instructions). This conference is being recorded today Thursday, April 28, 2011.

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

Thank you, Jo. Good afternoon, everyone, and welcome to the call. And obviously our purpose is to review our operations during the first quarter of 2011. And as always, I'm obligated to say that during this conference call we'll will make certain statements that may be considered to be forward-looking statements under federal securities law and the Company's actual future results may differ significantly from the matters discussed in any forward-looking statements. And we'll disclose in greater detail on the Company's Form 10-Q the factors that may cause such differences.

As we usually do, Paul Meurer, our CFO, will start this off and walk through our numbers.

Thanks Tom. As usual, I'll provide some comments and brief highlights of our financial results for the quarter, starting with the income statement.

Our total revenue increased 18.4% to $97.8 million this quarter, versus $82.6 million during the first quarter of 2010. Obviously, this reflected the significant amount of new acquisitions over the past year as well as positive same-store rent increases for the quarterly period of 1.1%.

On the expense side, depreciation and amortization expense increased by almost $3.8 million in the comparative quarterly period, as depreciation expense obviously has increased as our property portfolio continues to grow. Interest expense increased by just over $3.7 million and 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 both improved since last quarter, with interest coverage now at 3.5 times and fixed charge coverage now at 2.8 times.

General and administrative, or G&A, expenses in the first quarter was $7.87 million. As we've mentioned over the past couple of quarters, the increase in G&A this recently is due largely to recent hiring in our acquisitions and research departments. Our G&A expense has increased as our acquisition activity has increased, and as we have invested in new personnel for future growth.

Furthermore though, this quarter's G&A was also impacted by the expensing of $371,000 of acquisition due diligence costs, mostly related to the large portfolio acquisition that we announced last month. Our current projection for G&A for 2011 is approximately $29 million, which will represent less than 7% of our total revenues.

Property expenses were $1.983 million for the quarter. And of course 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 2011 is approximately $7 million for property expenses.

Income taxes consist of income taxes paid to various states by the Company, and they were $368,000 during the quarter.

Income from discontinued operations for the quarter totaled $396,000. 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 $222,000.

Real estate held for investment refers to property sales by Realty Income from our existing core portfolio. We sold three properties during the first quarter, resulting overall in income of approximately $174,000. These property sales gains are not included in our FFO or in the calculation of our AFFO.

Preferred stock cash dividends remained at $6.1 million for the quarter, and net income available to common stockholders increased to approximately $29.9 million for the quarter.

Funds from operations, or FFO, increased 21.2% to $56.6 million for the quarter. On a per share basis, FFO increased 6.7% to $0.48 for the quarter.

Adjusted funds from operations, or AFFO, or the actual cash we have available for distribution as dividends was a penny higher at $0.49 per share for the quarter. Our AFFO is usually higher than our FFO because our capital expenditures are fairly low and we have minimal straight-line rent in our portfolio.

We increased our cash monthly dividend again this quarter. We've increased the dividend 54 consecutive quarters and 61 times overall since we went public 16.5 years ago. And our dividend payout ratio has now continued to decrease so the quarter was 90% of our FFO and about 88% of our AFFO.

Turning to the balance sheet, we have continued to maintain a very conservative and safe capital structure. Our current debt to total market capitalization is only 25%, and our preferred stock outstanding represents just 5% of our capital structure. In March we successfully raised $300 million of new common equity in order to finance new property acquisitions. Since many of these acquisitions did not close in the first quarter, we had $130 million of cash on hand at March 31st. We also have zero borrowings on our $425 million credit facility, and 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.

Now let me turn the call back over to Tom, who'll give you a little bit more background on these results.

Thanks Paul. I'll go through each segment of the business and start with the portfolio. Obviously the portfolio continued to perform well during the quarter, and kind of all across the board operations continued to improve, which it had over the last few quarters. There is no significant tenant issues that arose during the quarter, and we have none on our radar. And at the end of the quarter relative to the largest tenants, about 15 tenants in the portfolio accounted for about 53.8% of revenue. And that's down 80 basis points from last quarter, primarily as a function of some new acquisitions and new revenue. And the average cash flow coverage of store level for the 15 tenants remains fairly high at a little over 2.3 times, about 2.33, so very healthy.

Occupancy at the end of the quarter, as you saw in the release was 96.8%. We had 81 properties available for lease out of the 2,519 in the portfolio. That's up 20 basis points from the last quarter and about 20 basis points from where we were a year ago. And fairly light activity in portfolio management, but consistent. We had 10 new vacancies, which was one less than last quarter, and we leased or sold 13 properties. And during the quarter, we added to the property portfolio and that's the reason for the uptick in occupancy. And still at 96.8% up in each quarter for the last few quarters as we expected, but pretty good results.

Same-store rents are starting to accelerate a bit. They were up 1.1% during the quarter. They were up 1% in the fourth quarter and 0.3% in the third quarter and we think we'll see those continue to increase as the year goes on and move at a modest pace, but positive.

And if you look basically where the same-store rent came from, we had four of our industries that had declining same-store rent, each of which were pretty modest and that was in restaurants, auto service, general merchandise, and drug stores. And the four declines were only about $333,000 in rent for the quarter.

Three of the industries had flat same-store rents, and then there were 22 that saw same-store rent increases. About half of that came from our tenants in the theater business, but we also had decent increases from the RV dealerships we have in the portfolio, which obviously is very nice to see coming off the last couple of years as their business has improved, and then in child daycare, and C-stores and the balance was pretty small. But altogether the 22 industries had about $1.2 million in increases, and so if you net that out you get to about $850,000 in same-store rents.

We continued to see occupancy gains in same-store rents this year and that's been going on now for several quarters. And just kind of looking into this quarter, once again we think we'll see something similar when we report next quarter.

We continue to be well diversified. If you look at the 2,519 properties, we added -- we're up 23 in the count from last quarter. That's in 31 different industries, with 125 multiple unit tenants in 49 states. And our industry exposures remain well diversified. Convenience stores now have jumped to our largest in the portfolio at about 19.9% of rent. We obviously like that industry.

Restaurants is now second and continues to come down. That was at 18.9%. That's down about 300 basis points from a year ago and we think that will continue to decline modestly. After that it jumps all the way down to theaters at 8.1% and is fairly well diversified.

As you see in the report, the largest tenant is Diageo at about 5.7%. Second is AMC at 5.3%, and again the 15 largest are about 53.8% of rent. When you get through the 15th largest tenant, you're down to about 2.2% of rent, and while not in the release, when you get to tenant number 28, everybody else in the portfolio is below 1% of the rent. And as we add more acquisitions here we think those percentages will continue to decline and we will have more diversification. Pretty much regardless of how you look at it.

From a geographic standpoint, the one state that's over 10% is California, however over half of that is Diageo. And if you look at the business that we have there that is, while centered out of California, most of the revenue is booked on a national basis and only about half the exposure really comes from California and then it drops to Texas at 8.9%, and Florida 7.5%. Those are obviously both very large states.

Average remaining lease term in the portfolio is at 11.5 years. That's up a little bit from last quarter and a function of acquisitions. And we think that'll continue to increase as we buy more things this year.

Overall then I think the portfolio's very healthy and just modest improvements continues here coming out of kind of a trough last summer.

Moving on to acquisitions, during the first quarter we were very active. We bought 26 properties for $150 million. The lease yields or cap rate's right at about 7.9%, lease terms a little over 16.5 years. And the 26 properties that we bought were leased to six different tenants in five different industries. And as we mentioned in the release, about $130 million of the $150 million was part of the transaction that we announced earlier in the quarter that will close over a couple three quarters.

And if we look at this now after completing the balance of the $544 million over the next couple of quarters, that'll get us to about $565 million for the year that will close right now, which is a pretty good number at this point in the year. We would anticipate cap rates at about 8% or so and if you look at our progress in closing, we closed another $100 million or so here in April and most of that again was part of the $544 million. And the rest of it'll be spread out over the next three, four months.

Obviously given that start, we think it'll be a very good year for acquisitions. We're still using in our guidance $600 million to $700 million in acquisitions for the year. We think that's pretty conservative and we'll update that as we do more underwriting and see what we end up -- we think we're going to close in the portfolio.

And as is typical in almost any time for us, we'll close about $20 million, $30 million a quarter and that's in smaller transactions, just by being out in the business. And then the overall acquisition volume for the year is going to be a function of how many larger transactions that we do.

Like last year where I think we closed three larger transactions during the year, that got us to about $700 million. And we've obviously started the year very well with one of them here. And while we continue to see some larger transactions, we'll have to see if there are any of them that the balance of the year come in for us. If they do obviously it could be another very big year in acquisition. And if they don't, given the start we have, we think we're still in pretty good shape.

Relative to cap rates and spreads, it is very competitive out there in the business. There are a lot of people with capital. I think we'll continue to get our fair share of that given our access to capital and ability to close. But I think we wouldn't want to describe it as not being a competitive environment, but that's been the case in most years.

Cap rates, I think if you're looking in the investment grade area, I think 7% plus, up in the mid to high 7%. And then as you move down, or move up the -- down the credit curve, then you're probably looking at things up in the 8% caps and on up to 9%. And for us this year we think we'll blend out again somewhere around 8%.

I think while that's consistent with last year, but down a little bit from previous years, given capital cost spreads, remain very high. So it continues to be a very accretive time to go out and acquire new assets and access the capital markets.

I think again this quarter and that -- it should be in the next few quarters, and certainly was last year, the main thing relative to our cap rates over the last year has been moving up the credit curve with acquisitions. About $130 million of the $150 million we did this quarter was with investment grade type tenants. That probably lops off 50 to 100 basis points off our yields from what is the traditional tenant base. But given that we can likely blend to about 8% caps this year, I think if you look at the historical spreads, even at working up the credit curve, the spreads are very attractive.

And as I've mentioned in the past, if we go back over the last 15, 16, 17 years since we've been public and you look at the average spread of cap rate over a nominal cost of equity, which was kind of taking your forward FFO yield and grossing it up for issuance, generally cap rates on closing have been about 105 basis points over that nominal cost of equity. And today we're closer to 150 to 200 basis points while working up the credit curve.

And I think what's also attractive about that today obviously if you can look at the debt -- equivalent debt of the tenant with the same maturity, you'll find that the spreads we're achieving here on doing the net leases are significantly higher what you'd see in the equivalent debt. And that's pretty attractive to add to the balance sheet.

Relative to the flow of acquisitions, I would say that the transaction flow that we have to look at is steady and consistent with what we had last year. We're not seeing a big increase. I know as we got through early and mid to last year we really accelerated in the volume we looked at. And I'd say that that has flattened out a bit, but still is a very good pace. And we're very active in underwriting, so it's a pretty good environment if we can find the transactions. And we are cautiously optimistic that we'll be able to do so in a competitive market this year.

Relative to our guidance, obviously getting a strong start to acquisitions and good performance in the portfolio is very helpful to revenue FFO and AFFO. And given a continuance of an accelerated acquisition activity here in the first quarter, we think that will continue and should be pretty additive to the FFO and AFFO this year.

A couple of items relative to the first quarter FFO. Paul mentioned there was a bout $371,000 in transaction costs on what we closed this quarter. And those should go away in the second quarter relative to the revenue stream created by buying those assets.

And then additionally, as most of you know, we also took the opportunity to access the equity markets during the quarter to pre-fund a good part of these purchases, so we had more shares out. And cash on hand, about $129 million that prepared for the balance of the closing of the rest of those portfolios. But obviously it's put us in a good liquidity position and given us the ability to continue to acquire.

And those all went into guidance. And then as I said, acquisitions, we're still using $600 million to $700 million and we'll kind of balance that and change as we go along.

For 2011 we're still estimating $1.98 to $2.04. That's 8% to 11.5% FFO growth and a little higher AFFO, $2.03 to $2.07, which would allow us to grow the dividend here in 2011 and at the same time, as Paul mentioned, bring the payout ratio down. And if we can have acquisitions accelerated that further that'd add to the numbers.

Paul mentioned the balance sheet and access to capital. There's no balance on the line and we obviously have enough cash on hand to close the acquisitions that we've done and with no debt coming due the balance sheet really is in great shape and debt to EBITDA about 4.5 times. And we're quite liquid.

The other thing I might want to mention this quarter we did put into effect a direct stock purchase program. Also dividend reinvestment program. And for those of you that haven't had a chance, we also reconfigured and relaunched our website, which we've tried to make very consumer oriented for our shareholder base. And so if you get a chance you might want to take a look at that some time.

But to really summarize the quarter, I think good stability in the portfolio, very nice and modest improvement. Good start to acquisitions and it's nice to see those acquisitions coming out of next year now starting to drive the revenue, the AFFO and the FFO. And that's always positive for dividend increases.

And with that, I think what we'll do, Jo, if you'll come back we'll open it up to questions.

(Operator instructions) Anthony Paolone, JPMorgan.

Tom, you may have touched on this in your comments and I may have missed it, but as you look at the other types of products that you're bringing into the portfolio with this large portfolio transaction, how big a part of the Company do you think that could become? Or how do you kind of put parameters around that like you've done on the industry sector with stuff you known historically?

It's a great question. We sat down a couple of years ago when we really started working on this and we started talking about targets. We really wanted to refrain from having targets. We have, as you know, we've never really said for the year we want to buy $300 million or $500 million or $700 million because then that tends to be what you end up buying, regardless of underwriting. And we'd rather focus on saying we're going to go into these areas, look at as much as we can, and then limit it to those things that really fit the underwriting characteristics.

So we don't have a particular target. I think the primary thing, rather than property type, is to really look at it and say over the years one of the best things we've done is gone from five industries in the portfolio to 30. And that had all kinds of benefits relative to risk reduction of our cash flows to the risk taken also due to us being able to allocate to a wider variety of industries. And we would like to move that up over the years to 40 or 50 and maybe even 60 industries that we can allocate capital to.

But the pace at which it comes in any particular property type we really don't have a target. We do continue to not want any industry to move over 20 and we're closer when they're down around or below 10%. But at the main part for right now as you look through getting this year and next year, we're still going to have the vast majority of our assets that are going to be in retail. And we'll add to these as they come along.

This was obviously -- you look at last year and we had the Diageo purchase, which was about $300 million, and this is $544 million, of which I think 67% of this was outside of retail, 33% in. And that -- those together are obviously some large numbers, but absent a couple three bigger transactions I think it'll be more incremental as we add them. And we don't have particular targets.

I mean how much does looking at single tenant office, single tenant industrial, add to your deal pipeline? Like do you -- like opening up to that stuff, does it just massively increase the deal flow or what you guys potentially look at?

Yes, it's interesting. It does massively open up the field to look at, but at the same time I think it really tightens the funnel through which things get through, because as we look at underwriting this type of asset, you have to sit down and say, okay as we're trying to underwrite things, what are we looking at?

And as you know, traditionally our underwriting has been a function of five or six things that we're looking for. And those are usually we want a tenant with multiple cash flows. So in retail that's a chain. If you look over to doing distribution or office, or manufacturing, we still want a very large company with multiple cash flow.

So if this is their only distribution facility or one of a couple, or this is only manufacturing, they have only one line of business, I think that's going to knock them out relative to being something we look at, even though the property type fits.

And then the second thing is I think for us, for it to be worthwhile for us to do, significant due diligence on a tenant is they're going to have to -- real estate's going to have to be important to them and they're going to need to have a fair amount of real estate so that the work we do could be amortized over a number of properties.

And then I think it also needs to be pretty critical to the manufacturing of their EBITDA. And as you know, we've always said that the most important underwriting metric we have is looking at the property we're buying, calculating the EBITDA and the idea of the cash flow coverage. And in some of these type of properties you don't have that. And when you don't have it, in order to still have a margin of safety, we're going to have to work up the credit curve as we do it.

So I think the majority of this that we would do would be less than -- or would be investment grade. And so that'll tend to knock out a huge part of the pipeline that's coming through the door now. And then second tenant with multiple cash flows. So we're seeing much, much more just generically come in the door, but a lot of it gets cuts out pretty quickly. But I think it'll add to our acquisitions in the next few years where I'd imagine it's somewhere between 10% to 20% to 30% to 40%, 50% of what we do may be in these areas, and if you add that to the overall portfolio it's fairly modest in terms of how quickly these will build.

Lindsay Schroll, Bank of America Merrill Lynch.

I know you guys said that flow that you're seeing is similar to last year, but how does it break out in terms of larger portfolios versus one-off acquisitions? Are you seeing more in one area or another or just the same as last year, across the board?

I'll throw that to John Case, our Chief Investment Officer. I think the flow's about the same. What do you think?

Yes, I think that the flow's the same. It really doesn't vary -- it's not varying much from what we saw last year. These larger portfolios are somewhat unpredictable. We've seen a couple of them but we've seen a lot of smaller opportunities as well, consistent with what we saw in 2010.

You know, Lindsay, I would guess, looking over the last 10 years we see anywhere from four to six of these things a year. And typically have bought zero to two. And then last year just happened to be three, and we had one at the beginning of the year. So they're out there. They do come to us, but I think last year the hit rate was just higher, but it looks similar this year.

And did you, on the last transaction you guys announced, did you base any competition for that deal? Just sort of curious how it was sourced -- came about.

I'll give you a little background. It came from a company out of Chicago called ECM and they had filed an S-11 to go public earlier last year and had been going through all of the various phases of that. And as we got into the fall, obviously the IPO market and REIT space became much more challenging. And so they started looking for other alternatives.

And we had been watching it and had an opportunity to sit down and talk to them about what they were trying to accomplish. And there were a number of other parties that were talking to them and looking at the transaction. And we were able to sit down with them and have just a very good discussion. We also like the people and hit it off very well with them. And the portfolio was a little over $700 million, it was very office centric. And then there was also a substantial amount of retail that they had, but was not part of their S-11.

And so when we sat down the first question is globally what are you trying to accomplish for your constituents? And as we were able to talk about that with them, we then were able to say office net lease probably has the less interest for us and we were able to substantially lessen that as part of the portfolio. And then retails very interested us, so we could add that back in and get to a number, in this case $544 million, that met their needs. So I think a lot of the people that were talking to them kind of moved to the side, as we were able to get a larger, more holistic type of situation together.

And then I think after that there were probably a couple other parties that were still interested, but I think our ability to close and track record of doing so without re-trading and doing other things was helpful. But it's a nice relationship that was formed with the people.

Jeffrey Donnelly, Wells Fargo.

I like Tom's picture on the website by the way.

What I meant is please look at the website sometime later.

If I can summarize, Tom, I think you've been saying that compared to the last 30 years you think the next 10, the fundamentals in, I'll call it consumer-driven businesses, will be relatively softer and that's leading you to look outside to other types of properties.

You've got a fairly unique cost of capital right now, so I guess I'm curious, what prevents you from taking bolder action? I mean UCM certainly was one step, but should we expect more transactions like that rather than just sort of onesies, twosies in, whether it's (inaudible) or office? I mean --

We'd certainly like to do that. When you start looking at very large portfolios I think they become challenged for enough of that portfolio to be something that makes it through underwriting where there's a huge population of them out there. Although we'd love to see that happen.

And I like to think between this transaction and the Diageo last year, $800 million something, of which $600 million, $700 million plus was in these new areas was fairly bold for us. But the population group I think is likely to be in little smaller chunks. But we'll be as bold as we can be as long as it fits the underwriting.

And I don't want to characterize that we're negative on retail. We just think, as you said it'll be a little more challenge than it has been in the last 20 years. And then the motivation for doing this kind of moves into three or four different things. But we'll move as quickly as we can move, but the underwriting's the secret to this and you look back on the last 20 years and we could have bought a lot more than we did and then we always try and go back and historically watch what happens to it and we would have a lot more problems than we would. So it's a -- we'd like to do big deals, but they'll come as they come.

I'm curious then what appetite do you have for selling assets?

Well, that's an interesting one. I think we'll be more active in selling assets for not -- perhaps not here this year but also in years in the future, that's something that we'd like to run at a little higher rate to more actively manage the portfolio. And if you'll allow me, Jeff, maybe I can kill two birds with one stone and kind of explain for folks what are the three or four things we were talking about that's kind of led us to do what we're doing. And then secondarily, where we'd like to go with the portfolio and that'll speak to maybe selling more. Is that all right?

Sure.

As we a couple three years ago, went through a strategic planning process with our Board that we hadn't done in quite a while there, the first thing that Jeff alluded to was looking at the consumer retail business and saying look, it could be a little tougher. Obviously the consumer levered up in the last 20 years and you had good job growth and retail was just very good, and it could be a little softer in the next 20 years.

And then second, as you look at what we did is we really expanded our industries from five to 30 industries, but we're getting relatively penetrated in retail to the extent where if we add anybody new I think we'd move into the big box space, which is not an area that we want to do that.

And then the third thing relative to retail is if you look at what we buy, which is the smaller net lease retail box, it has gone more mainstream over the last five to 10 years and I think it's a little more competitive in moderated cap rates. And so looking at that, looking outside was something that we wanted to do.

And I'll really tie to going from five to 30 industries and wanting to expand some more. As we do that, being penetrated in retail, you start looking outside of retail, like we did with Diageo. And to get that non-retail exposure to get in the new industries, you're going to get the non-retail type property. So it's really more driven in terms of wanting to diversify not the assets and the different property types, but really more industries that we can go work in to do net lease financing.

Now this next part kind of speaks to going up the credit curve and then also probably selling a little more in the future. One of the things we talked a lot about going through this strategic planning evolution is looking the last 30 years we've been pretty well in a declining interest rate environment. And if you look what that did for people in terms of their growth rates, in terms of how they handled their balance sheets and their debt levels, and how it changed peoples' behavior, it's pretty stunning as a lot of people who use a lot more debt.

And we kind of asked ourselves if you then look forward over the next five, 10, 20 years, obviously interest rates have dropped a lot, and they could stay low and we'll assign a probability to that and say, for lack of a better number, 25%.

But then you start saying what are the chances over the next five to 10 years that interest rates rise? And you start by saying something like, well what if interest rates go up say, 200 basis points for permanent financing the next five to 10 years? And you kind of walk through your business and say what would that do? And you look at your tenants, you look and kind of refinance their balance sheet for them at 200 basis points higher, and then say how comfortable am I with that? And you're probably okay, or at least we are because we have high cash flow coverages.

And then say let's give that a 50% probability, which we think is fairly reasonable, given it's 200 basis points off some very low interest rates. And you'd say okay, what would that cause us to do? And then I think you kind of take an outlier and assign a 25% chance that interest rates go up significantly higher, and maybe people have to refinance their balance sheets at 400 to 500 basis points higher. And you look at that and say what does that do? How comfortable are you with that? And you give that a 25% probability.

And when you sit down and do that, kind of three or four questions come up. One is what do you want to do with your own balance sheet? And I think the answer is while we have modest debts, if we thought that interest rates could go up substantially we'd probably want to moderate our leverage. And as Paul mentioned earlier, debt's down to about 25% of the balance sheet. And part of that's a function of having done three equity offerings in recent months. So that's one thing we're trying to do.

And then what does it make you do relative to your existing portfolio? And if you do take the tenant base and you do run higher refinancing rates off those, and then you marry it to look at the properties and what their cash flow coverages are, and then go as step further and look at what markets they're in and where job growth is and population growth, we're trying to go through a phase of taking the whole portfolio kind of tenant-by-tenant, industry-by-industry, and property-by-property, and laying out on a risk standpoint where we think the risk sits. And then think about over, not right away, but a period of three, four, five years, what you'd want to be selling and how you'd want to do it. And we're kind of in the midst of that right now.

And then the last step for that is obviously what do you do with your acquisitions? And I think going up the credit curve, if you can do it, and spreads allow us right now, is really going to increase the quality of the portfolio. And if you look at possibly higher interest rates at some point down the road, or at least the probability of it, that is going to take some risk out of the portfolio.

So if you kind of look in context of the last year, we started working on this a couple three years ago. We've closed in $1 billion, $2 billion or so, or we're about to close in the last 12, 13 months. $700 million of that has been in new industries. Probably $750 million of that has been up the credit curve into investment grade, and we've tried to fund it primarily with equity in the last few.

So that's essentially what we're trying to do is take debt down, trying to manage the portfolio for what may be a little more challenging environment and I think we're off to a good start. And doing it while you can raise FFO because cost of capital as good has really been a nice advantage to do that and be able to raise the dividend and get payout ratio at the same time. And then if you look forward and you say okay, five to 10 years from now, down the road interest rates are higher, I think we'll be very well served by it. And if interest rates don't go up, then we're in good shape and we'll have access to leverage. So that's kind of what's driving all of this.

That's helpful. Actually if I could ask one last question. Just about the different types of assets you'd consider. You mentioned looking at assets that weren't difficult to separate the earnings generation from the asset itself. What do you think about healthcare assets or like lab space assets? I know there's another that's in San Diego area that has assets like that. Or data centers? I mean all three of those are arguably ones where it's difficult to separate, they're kind of niche-y. There's enough of a cap rate difference that it could make some sense for you guys.

Yes, it's -- part of this that kind of when I went through background that I'll also allude to that what as worked for us over the years is working into sectors that aren't efficiently financed or mainstream, and for us that was fast food and childcare, and then auto service. And each of those became mainstream.

So we looked a few years ago at healthcare and they're just a lot of people out financing that and they're fairly well funded. Data centers, there's some people running after that. And each of those are specialized, have some pretty good expertise, so we haven't seen those as huge areas for our expansion. But we're open to anything that we can underwrite, understand, and has either a cash flow coverage we can look at and we're confident in that if they left the building they'd lose the EBITDA or work up the curve. But those three areas we've kind of watched with interest, but I think they're being pretty aggressively financed right now by other people.

Gregory Schweitzer, Citigroup.

I'm here with Michael Bilerman as well. Just to follow-up on some of the previous questions. In regards to new industries, have you narrowed down a few or have done the due diligence on (inaudible) talk about as you continue diversifying up to the 50, 60 industry target?

We're kind of in a mad rush to do a lot of the one start. I'd have to say kind of no. As we said last year, we had done due diligence on a number of areas and gotten nowhere. Wine was one, the beverage industry and so that's one that we really had done a lot of work on. Another one is probably four, five years ago we assigned one of our people for a year to work in the banking industry and we really aggressively went after, talked to every bank in the industry in terms of what they were doing. But at the time they really didn't need capital and when we went back and looked at them again a year ago, some of them needed capital, but we couldn't figure out what their credit situation is. But we've done a lot of work there, but seen nothing out of it.

There's probably three, four more behind that and then we're really -- it kind of looks like it did here in 1997, 1998, 1999 when we added research. We're really starting to widen the net now and look broadly over a lot of them. And at the same time trying to see where there's work to be done. But we don't have big shining targets where we've done a huge amount of research. We're kind of going after them now as we do them.

And then as you go through the internal reviews that you were talking about earlier, any sense on how much or what portion of the ECM portfolio you might want to sell down the road or are you comfortable with all the tenants and industries for the long haul at the moment?

We're very comfortable with the tenants. And I mentioned before that office for net lease is one for us that's a little harder to get our hands around relative to release at the end of it and is an open-ended question. So that's where we probably have less interest.

We did substantially get the office down to this where it was just three buildings and we're comfortable with them and with the prices we paid. That's one option to stick back there. But given my conversation earlier about the entire portfolio I think there's more things there that we'd want to sell than in this particular area.

But when you look at the distribution, the tenants, the biggest tenant in here is FedEx with eight of the properties, that'll now be about 2% of our revenue. And the distribution people are investment grade. The offices there are close and the manufacturing is [Midwest] Backhoe and Coca-Cola. So those are all areas that we're very comfortable with who we have and I think sales would really come out of the existing portfolios in some areas that tenants and individual properties where we think there might be more risk.

I just had one more. The properties under development that you acquired in the quarter, was that outside of the portfolio deal?

Yes, it was. And we're not doing a lot of development. And I'm looking --

We only have two currently under development.

Right.

And then we have a couple other properties that are more or less -- I wouldn't call them redevelopment, I'd call them added investment into existing developments where they're expanding on site. But really we just have two properties in the entire portfolio that we were funding new construction from day one.

And was that a unique opportunity or is that something you might continue looking at? And how do you evaluate that?

Existing tenants who we have a relationship with.

Yes, we've got a couple of tenants, one in particular that we've done a lot of their new stores and very consistently they're extraordinarily profitable and so we have a comfort level with them. And that's the majority. And they're just new stores they're opening, but like I said, we'd normally like to buy existing with cash flow coverages, but we have yet to find any that these guys didn't open that didn't end up with high cash flow coverages. So while it's very small as part of the overall acquisitions, we're comfortable with these people.

And then some others, it's when a tenant will come to us and say hey, we want to expand this particular site, there's some excess land. Obviously we're in the mode to invest, so if they're willing roll the lease back to a full term and allow us to do some added investment, we're happy to do it. But it's relatively small.

Todd Lukasik, Morningstar Securities.

Just following up on the development. Can you guys disclose how much more you're going to be spending and when they're expected to be completed?

I think it's $16.2 million I believe is the number. And there's about $7 million more to fund. So relative to the size of the Company, it's not huge. And those are all subject to leases that we've written before the development happens and that the completion is guaranteed by the tenant, so there's no development risk.

Right, okay.

We have the cost and timing taken care of relative to development risk.

Right.

And then just thinking about lease expiration, the retail versus the non-retail. Obviously on the retail side the EBITDA or coverage of rent gives you some good indication as to whether or not the tenant is going to renew or it'll be relatively easy to release upon expiration. You mentioned that sometimes on the non-retail side you guys either aren't getting that data specifically or it's harder to identify. Are there any other sort of metrics that you look at there or is it just moving up the investment credit curve that gives you confidence at the lease expiration?

It is moving up the credit curve that makes us comfortable that we'll get paid from now to the lease expiration. (Multiple speakers) not having EBITDA they can walk away from. And as we did this, part of our process and why it's going to be a very big funnel. For instance if you're looking at distribution and you have a site, you want to make sure that first of all it's built to current standards. Second you want to know what they're doing with it and how it ties into their other operations. Is it a distribution facility that is sitting next to one plant? What if the plant closes? Does it serve two or three plants?

Second is that it that a distribution facility that is fully built out, ideally what you probably want is additional land and a lot of these people like to put additional land, so as time goes on and they need to expand their business they can do it. That gives you an opportunity to rewrite the lease up to a longer term again. So we're looking for that.

And then up front in these we're trying to make sure that the prices we're paying and that the costs we have, as you get more into the industrial types, give us some margin of safety there. So I think it's don't overpay, really understand the use they have, make sure they're up to current standards. But have a good feeling that that is a particular one of their distribution and manufacturing facilities that they're likely to use for many years to come because it's close to the headquarters or the distribution's close to two manufacturing facilities.

So we're really working on that and working up the learning curve, but we start with getting a long-term lease and investment grade credit.

Rich Moore, RBC Capital Markets.

On the ECM transaction is there anything else in their portfolio? Or was this the whole thing? I mean would you add something else that they have or are you kind of done with them?

No, we're done for now. They're an ongoing entity that will continue to invest for the benefit of their investors. And we like each other and so we'd like to have an ongoing relationship if there's some things to do in the future.

Relative to what they have now we obviously were able to take some things that didn't fit us as well or we didn't know as well and move those out. And those things that did fit us we were willing to do all that they had or fit their needs for sale. So I don't see a lot to do with them right now, but there may be over times and stuff we can do and they're good people and we wouldn't mind that.

And then do you still plan to close everything in ECM that you're going to do by August -- by end of August I think you had said before?

Yes, that's our best guess right now. I think by the end of August we should be able to do it. But as you know, there is some debt to assume, which we typically want to pay off as fast as we can, because we don't hold mortgage debt. But when you get into the assumption some mortgage servicers -- things can slide a bit. And at this point that and maybe a couple other closing issues could hold us up. But that's the plan for now.

And speaking of the debt, I think you had said you wanted to eliminate like $223 million out of the $291 million.

Yes.

Is that done? Have you done that or are you still working on that?

We're working in that process and that'll continue through closing and after closing. There maybe a more -- another $20 million we have to take on or so just to as a function of it turns out it was uneconomic to pay it off. But that'll slide and again that's the mortgage servicer and the people we work with. So happy to get it all paid off, but don't want to do it when it becomes economic. It's split a little bit, but not that much and we're working on it.

And then I think you sold three vacancies in the quarter. Does that sound right?

We sold three properties in the quarter, most likely we found somebody who wanted to occupy them but we preferred to sell them rather than lease them.

And then will that continue do you think? I mean is there a, I don't know, an interest from tenants to buy the properties and be owner occupied kind of thing that would take some more of those 81 assets that you have that are vacant?

To the extent that anytime we get out of the 81 we seem to add some. And that's kind of the normal rate that sits there given we're up to 2,519 properties. But typically what happens is we'll go out to lease those and when we find a tenant, it either is one that fits our portfolio, in which case we'd rather keep it on the books, or it's one that doesn't fit the portfolio and at that point we like to help them own it. And that has been running anywhere -- I just happened to look at that this morning -- anywhere from $15 million to $35 million a year for the last 10 to 11, 12 years in sales.

But what I think, maybe not this year, but moving into next year and the year after, I think sales will accelerate, but that's more a function of just working the portfolio, not vacancy and re-leasing.

And then the last thing I had is was there some particular impetus to do the dividend reinvestment plan now? I would have thought -- I didn't even think about it that you guys would have had one of those before. And I guess you did and why I guess now did you suddenly decide that's a good idea?

Yes, it wasn't suddenly. Out of this strategic planning process there were a number of initiatives. And one of them is one to really build our brand. The Monthly Dividend Company, which worked very well for us in recent years in the financial community and continue to do that, really with that income oriented investor. And so it was all tied together with the relaunch to the website, which is the first step of a program there over the next few years, and adding in the direct stock and the dividend reinvestment at the same time with that.

So we really held off on it, knowing for a couple three years it was coming, until we could relaunch the website and really start the initiative there. They were tied together.

Joshua Barber, Stifel Nicolaus.

Most of my questions have been answered. I just had a quick one, as long as we're on acquisitions. Is there any interest in perhaps some public deals, not so much non-IPOs, but perhaps other REITs out there? Or is that something that you're not really thinking about right now?

That is one we're always open to, but it has long-term been a challenge for us. There was a period there from probably 1997 to 2008 where we were offered seven or eight and we got very close with a couple and we did a tremendous amount of research.

And in each case what it came down to is you work so hard quarter-by-quarter to meet your underwriting characteristics to your business, and then to take a large portfolio underwritten by somebody else all at once, that is diversified where you have to do all that work, and it's already been done and they've done it differently has made it really problematic to do so. And in order to do it you'd enter looking for some discount that would try and reduce or mitigate that risk of taking on other peoples' underwritings. And in each case we couldn't quite get there and I've become a little suspicious that that's something that will happen in the long term, but I think it's appropriate to remain open to the possibility.

Tayo Okusanya, Jefferies & Company.

Congratulations on a good quarter. Three questions. In regards to the guidance outlook on the acquisition side, how should we be thinking about how you plan to fund that permanently? Should we be thinking about what you've done in the past where once you announced a deal you kind of put in equity a little bit after that? Or are you kind of thinking about funding this a little bit different on a going forward basis?

We pre-funded a lot of this with the equity raises. And if you look at the debt that we'll assume on this, albeit we're trying to pay it off, I think right now cash on hand gets us a long way towards funding the vast majority of this purchase.

We still have the line sitting there. If we did small acquisitions on a regular basis we'd build the line up to $100 million, $150 million before you do something. If you get a large acquisition then I think you try and fund it right away so you don't create a lot of overhang. And given what I said earlier, I think equity at these prices would be our choice. Preferred's also attractive, but if you get into a very large transaction, this is interesting because we did it with Diageo last year, $300 million and we were wondering about what overhang issues would be to equity, so we started with debt. So all cards are available, equity though is choice number one, preferred two, but debt if we think we need to do that, if we're going to have to do multiple financing.

And then just kind of given where cap rates are generally you seem to be heading in the market. Any interest in doing more dispositions and recycling the -- some assets in the portfolio?

Yes, as I mentioned a little earlier, we're really in the midst of a project here to take the whole portfolio and look at it from a tenant industry basis and then separately by a property basis. And really we've taken it, we've put together spreadsheets and then put in each market that they're in and rated the market for job growth and population type of job growth, and all of that. And we're in the middle a process to do that.

And at the end of it what we want to kind of do is have internally our entire portfolio scaled from most risk to less risk. And at that point, Tayo, I think we will want to do more active portfolio management. And selling a few more, but I think it's going to take through this year to get a lot of that done.

We also want all the acquisitions we've done so far this year to have the spread hit the bottom line so we can lower the payout ratio while increasing the dividend.

One of the interesting things about actively managing the portfolio is if we have say, $300 million of acquisitions with an 8 cap that the cost of capital is 6, and we're clearing $2 million and we've got $300 million of that, that's $6 million and it's $0.045, $0.05 of new FFO and spread. And to the extent that we take $100 million out of the existing portfolio, yielding us 8 and sell it, we take about $0.0156 for each $100 million with a 200 basis point spread out of our growth for acquisition. And that assumes that the cap rate on what you're selling equals the cap rate on what you're buying.

If you're selling those things you think might have some more risk down the line, I think you want to assume that the cap rate's a little higher. And so it does eat into your FFO, so I think each year it's going to be taking a look at FFO growth, getting to a good rate of FFO that allows you what you want to do relative to raising your dividend. And then thinking if there's some of that you might burn off by taking some risk out of your portfolio. And I think it's going to be year-by-year and it's likely next year's the start year we start doing that in the portfolio. But it is something I have an interest in.

Andrew DiZio, Janney Capital Markets.

Just a kind of a follow-up to Richard's question about the receptions of the direct programs and direct stock purchase options. If you kind of have an early read on how much capital that'll provide each quarter. Do you think it's the kind of thing that can fund a small one-off transaction you see every quarter?

I think it's very small, I really do. It is something that for years we didn't have because we thought it was really small and most people who did it had the Company pay for it, which means the existing shareholders. We've set it up so the people who use it pay for it. And we just wanted it as an option. Kind of the overall program with the website and what we're doing is to kind of be able to work directly with our consumer there. But we assume most of their purchases are going to come through their brokers, be that in having a full service financial advisor. Or whether they do that in some other fashion. And it's really not through us, the majority of the purchases will come, but we did want to offer it as an option and we though a good time to do it was when we put the website out.

But I don't think it'll be big and we'll report it as we go along, but we're only a couple of weeks into the website and I think 10 or 11 days relative direct stock purchase. I know somebody's done it, but don't have a read on volumes, don't think it's big.

Ladies and gentlemen, this concludes the Realty Income's question and answer session. I'll turn it back to management at this time.

Well, thank you everybody for taking the time. And we'll look forward to seeing you all soon at NAREIT and ICFC. And thanks again.

Ladies and gentlemen, that does conclude your conference for today. Thank you for using ACT teleconferencing. You may now disconnect.