Realty Income Corp (O) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen and thank you for standing by.

Welcome to Realty Income's third-quarter 2012 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 also being recorded today, October 25th of 2012.

I would now like to turn the conference over to our host for today, Mr. Tom Lewis, CEO of Realty Income.

Please go ahead, sir.

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

Welcome to the conference call to review our operations and results for the third quarter.

In the room with me today, as usual, is Gary Malino, our President and Chief Operating Officer; Paul Meurer, our Executive Vice President and CFO; and John Case, our EVP and CIO; and Tere Miller, our Executive Vice -- or, excuse me, Vice President -- almost promoted you, Tere -- of Corporate Communications.

And as always we'll say during this conference call, we will make certain statements that may be considered to be forward-looking statements under federal securities law.

The Company's actual future results may differ significantly from the matters discussed in the forward-looking statements and we will disclose in greater detail in the Company's Form 10-Q the factors that may cause such differences.

Our call today will focus on our third-quarter and year-to-date operational performance for the Company.

But before we get into that, let me start with just a brief comment on our merger with American Realty Capital Trust, or ARCT.

As most of you know, we announced on September 6 that we had reached an agreement to merge the two companies.

And then after our announcement of the agreement we filed an S-4 proxy with the Securities and Exchange Commission, which is where it sits today and it is currently in review.

Following that review, which we anticipate will conclude in the near future, we also anticipate getting a final and then effective proxy sent out to all of the shareholders of both companies.

And at that time we'll be having an opportunity to talk to all of the parties involved about what we think is an attractive opportunity for the shareholders of both companies and would then move forward towards an approval of that transaction and then ultimately close it.

But we'll engage in that time in I'm sure a fair amount of discussion about it.

We continue to anticipate closing the transaction towards the end of the year.

So we look forward to more discussion on that once the transaction proxy is effective for us.

I'd invite those with any additional questions for now, if they haven't, to review the S-4 that's currently filed at the Securities and Exchange Commission and is available on EDGAR.

And obviously, after we have comments we'll make any changes and get that out.

Moving, then, on to our operating results, let me start with an overview of the numbers.

And, Paul, as usual, if you'll do that for us?

Thanks, Tom.

So as usual I'll just comment briefly on our financial statements, provide a few highlights of our financial results for the quarter, starting with the income statement.

Total revenue increased 13.2% for the quarter.

Our revenue for the quarter was approximately $120 million, or $480 million on an annualized basis.

This obviously reflects a significant amount of new acquisitions over the past year.

On the expense side, depreciation and amortization expense increased by about $6.2 million in the comparative quarterly period.

Depreciation expense obviously increased as our property portfolio continues to grow.

Interest expense increased by almost $1.2 million, and this increase this quarter was due to our credit facility borrowings throughout the quarter.

On a related note, our coverage ratios both remained strong, with interest coverage at 3.7 times and fixed charge coverage at 2.7 times.

General and administrative, or G&A expenses, in the third quarter were approximately $9.3 million, similar to the rate for last quarter.

Our G&A expense has increased this year as our acquisition activity has increased.

We have added some new personnel throughout the year, and our proxy process this past spring was more expensive than usual.

We expensed $795,000 of acquisition due diligence costs during this quarter.

And our employee base has grown from 80 employees a year ago to 92 employees today.

However, our current total projection for G&A for all of 2012 is approximately $36 million, which will still represent only about 7.5% of total revenues.

Property expenses were just under $2 million for the quarter, and these are expenses associated primarily with the properties that we have available for lease.

Our current estimate for property expenses for all of 2012 remains about $9 million.

Merger-related costs, this new line item, refers to the costs associated with the ARCT acquisition.

During the quarter we expensed approximately $5.5 million of such costs.

And this amount includes accruals for some of the expected total costs for completing the transaction.

Income taxes consists of income taxes paid to various states by the Company and they were just over $400,000 during the quarter.

Income from discontinued operations for the quarter totaled $1.9 million.

This income is associated with our property sales activity during the quarter.

We sold 11 properties during the quarter for $15.8 million -- an important reminder that we do not include property sales gains in either our FFO or our AFFO.

Preferred stock cash dividends totaled approximately $10.5 million for the quarter.

This increase compared to last year obviously reflects the issuance of our preferred F stock earlier this year.

Excess of redemption value over carry value of preferred shares redeemed was not this quarter, but it is in the year-to-date column.

This refers to the $3.7 million noncash redemption charge in the first quarter associated with the repayment of our outstanding preferred B stock with proceeds from our preferred F offering.

A reminder that a replacement of the preferred B stock in our capital structure did save us about $1 million cash annually.

Net income available to common stockholders was about $27 million for the quarter.

Beginning this quarter we have included a normalized FFO calculation.

Normalized FFO simply adds back the $5.5 million of ARCT merger-related costs to FFO.

We believe normalized FFO is a more appropriate portrayal of our operating performance and is consistent with our public FFO earnings estimates and first call FFO estimates that analysts have already published [on us.]

Normalized FFO per share was $0.52 for the quarter, a 4% increase versus a year ago.

Adjusted funds from operations, or AFFO, or the actual cash that we have available for distribution as dividends, was $0.52 per share for the quarter, a 2% increase versus a year ago.

Year to date AFFO was $1.52 per share, also a 2% increase versus last year.

While it may vary by quarter, our AFFO annually will continue to be higher than our FFO.

So far this year our AFFO has been $0.05 higher.

Our AFFO has been higher because our capital expenditures are still fairly low in the portfolio.

We continue to have minimal straight-line rent adjustments in our current portfolio and we have some FAS 141 noncash reductions to FFO for in-place leases acquired in some of the larger portfolio transactions that we've done.

And then in 2012 specifically we have the $3.7 million noncash preferred redemption charge.

We increased our cash monthly dividend twice during the third quarter, including the larger $0.06 annualized increase in August.

We have now increased the dividend 60 consecutive quarters, and 68 times overall since we went public 18 years ago this month.

Our AFFO dividend payout ratio for the quarter was 85%.

Briefly turning to the balance sheet, we've continued to maintain a conservative and safe capital structure, we think.

Earlier this month we raised $800 million of new capital with our issuance of $350 million of 2% unsecured fixed-rate notes due in 2018 and $450 million of 3.25% unsecured fixed-rate notes due in 2022.

We were very pleased with the successful offering and we are grateful for the bond investors who continue to support us with their capital.

With the bond offering proceeds we were able to completely pay off the borrowings on our $1 billion unsecured acquisition credit facility, which continues today to have a zero balance.

We also have today an excess cash balance of approximately $160 million from the bond offering proceeds.

Our current total debt to total market cap is 30% and our preferred stock outstanding still is only 7% of our capital structure.

Our only debt maturity in the next three years is a $100 million bond maturity in March of next year.

So, in summary, we currently have excellent liquidity and our overall balance sheet remains very safe and well positioned to support our acquisition growth, including the ARCT acquisition later this year.

Now let me turn the call back over to Tom and he'll give you more background on these results.

Thanks, Paul.

I'll kind of walk through, as is our tradition, the different areas of the business.

And let me start with the portfolio.

During the third quarter the portfolio continued to generate very consistent cash flow, with tenants doing well and no significant issues arising outside of our normal operations.

At quarter's end our 15 largest tenants accounted for 46.8% of our revenue.

That's down 520 basis points from the same period a year ago and 170 basis points from the second quarter.

So our acquisition efforts continue to reduce concentrations in the portfolio.

The average cash flow coverage of rent at the store level for the tenants remains high at just over 2.5 times, which is very little movement from last quarter, with a similar number, but quite healthy.

We ended the third quarter with 97% occupancy and 84 properties available for lease out of the 2,838 we own.

That occupancy was down about 30 basis points from the second quarter.

For the quarter we had 27 new vacancies.

That is a little higher than we usually get and was really a function of we have 25 Buffet restaurants that came off lease right at the beginning of the quarter.

And we had seen those coming off, so I think I had made some comments on last quarter's call that occupancy may be a little softer, but not much, at 97% for the quarter.

During the quarter we did release 15 of those.

We've released another couple since the end of the quarter.

And they make up a good part of the 18 properties that we leased or sold during the quarter.

We also acquired 87 properties and that was the reason for the movement, but quite solid at 97%.

As I've mentioned for the last few quarters, and we will each time now, there's three ways to calculate occupancy.

One is taking the number of vacant properties, which is 84, and dividing it by our total of 2,838 properties.

And that's how we get to 3% vacancy and 97% occupancy.

A second methodology is take the square footage that is vacant and divide it by the total square footage.

That would give us a 2.1% vacancy and 97.9% occupancy, a little higher, 90 basis points higher than the first method.

And then the third way, which is more of an economic way of looking at it, is take the previous rent on vacant properties and divide it by the sum of that number and rent on occupied occupancies.

And if you use that methodology, vacancy is only about 1.7% and occupancy 98.3%.

Obviously, any of the three represent fairly high occupancy.

And in the press release we use physical occupancy which is the lowest of the three.

Looking at the next few quarters, leasing activity today is brisk.

Lease rollover is reasonable.

The tenants are generally doing well.

So we think occupancy should increase a bit in the fourth quarter and increase a bit going into early next year.

So we think the portfolio's fairly sound, very sound, from an occupancy standpoint.

Same-store rents on our core portfolio decreased 1% during the third quarter and 0.8% year to date.

As we've talked about for several quarters now, if we exclude the Buffet's and Friendly's reorganization rent adjustments, same-store rents on the balance of the portfolio increased 1% during the third quarter and 1.1% year to date.

As we look forward the impact of those two will now start rolling off and we think that we'll probably have flat same-store rent in the fourth quarter.

And then in the first quarter likely go back to the more typical increase that we've had in the past of about 1% same-store rent growth.

So we're optimistic relative to occupancy and same-store rent growth over the next couple of quarters.

Diversification in the portfolio continues to widen -- 238 properties, which was up over last quarter; 44 different industries; 144 different tenants; and the footprint in 49 states.

From a geographic standpoint there are no meaningful concentrations around the country.

And probably more important, industries exposures are very well diversified, again, with 44 industries now.

And concentrations in the larger industries are generally continuing decline each quarter.

As you probably saw in the press release, convenience stores, which is our largest industry at 16.3%, is down 60 basis points from last quarter and 200 basis points versus a year ago.

Restaurants -- if you combine both casual dining and quick service, now down to about 13.2%.

That's off 60 basis points from last quarter and 410 basis points versus a year ago.

And I think more importantly of note there to us is really the decline that we've had in casual dining, as we acquire in other areas and we've been selling off properties in this area.

And we think that will continue.

Casual dining's down I think 360 basis points year to date.

And as the chart on page 11, I believe, in the press release shows, we're down to about 7.3% in that sector from over 14% in the last five years or so.

And we will continue to reduce that.

Theaters are at 9.5%.

That's down a little bit, up for the year.

Health and fitness also down a little bit, at 6.7%.

We continue to like both of those sectors, theaters and health and fitness, and I think we'll be adding to them.

And then the only other category, industry, over 5% is beverages.

And additionally, this quarter we added 6 new industries for the portfolio for the first time.

So I think we're in very good shape in keeping industry concentrations reasonable and generally widening out the diversification.

This quarter -- in our industry table in the back of the press release we separated our retail industries from our nonretail industries for the first time, which should make it a little easier for everybody to see the activity in each of those areas and basically how it's moving over time.

And we hope that is helpful.

From an individual tenant standpoint, no tenant now represents more than 5% or more of our overall revenue in the portfolio.

Of an interesting note, this is the first time in the 43-year history of the Company that that has been the case, where no tenant is over 5%.

So we continue to become more diversified there.

Our largest at 4.8% is AMC; that's down a bit.

LA Fitness and Diageo are at 4.7%.

And then everything else is under that.

The 15 largest tenants, I mentioned, is 46.8% of revenue.

When you get to the 15th tenant you're looking at only about 2% of revenue.

When you get to number 20, it's about 1.5%.

So we continue to be well diversified.

The other thing I would note is the continued transformation in our top 15 tenants over the last few years.

As I mentioned, concentrations are down quite a bit.

Tenant quality continuing to move up a bit and industry representations are changing as we continue to focus on moving up the credit curve and away from some areas we think are vulnerable to a consumer downturn.

And we think the list will continue to transition in coming quarters, based on the transactions we're undertaking now, where we're quite active.

Relative to moving up the credit curve, three years ago essentially none of our rent came from investment-grade tenants or their subsidiaries.

It's a 43-year old company.

That's worked very well.

In that entire period occupancy has never been below 96%.

And obviously earnings and dividend growth has been excellent.

But it really is -- we are trying to make a move in that direction.

And as of the end of the third quarter, that numbers stand a little over now 20% of the portfolio is generated by investment-grade tenants.

And upon the closing of the ARCT transaction that would be roughly 35%.

And we continued here in the third quarter and we will in the fourth quarter, to buy additional properties leased to investment-grade tenants.

We're also adjusting the portfolio by accelerating property dispositions a bit in certain industries.

Year to date we've sold 30 properties for $34 million.

That's versus about $12 million of sales for the same period a year ago.

And we think that will continue to increase.

We'll likely sell around $20 million or so in the fourth quarter.

That will get us up around $55 million, and then we think likely run in the $75 million to $100 million run rate, perhaps a little higher, over the next year or so.

Almost all of the sales to date, as a matter of fact all of them out of the investment portfolio where we target an industry, have been out of the restaurant category, with the majority being casual dining restaurants.

We have been pleased that the cap rates for sales have been a little better than we thought.

On the properties that have been closed to date, the cap has been about 8.19% and on the properties that we currently have under contract for sale now it's about 7.55%.

So it's been a good environment to be active out in dispositions for us.

Finally on the portfolio, our average remaining lease term remains very healthy at 11 years.

And so, given the long-term leases that we have and increased diversification in the portfolio and then the idea we think that same-store rent should accelerate and also occupancy a bit, we're very optimistic and continue to see very stable revenue production out of the portfolio.

Let me move on to property acquisitions.

We are obviously having a lot of success on that front for the first three quarters of the year.

We see that continuing this quarter and into next year.

And let me turn it over to John Case, our Chief Investment Officer, and you can walk people through what we're seeing.

Okay.

Well, we had a very active third quarter for acquisitions this year.

We acquired 87 properties for approximately $496 million.

That was our second most acquisitive quarter in our company's history.

We acquired these properties at an average cap rate of 7.11% and the average lease term was 13 years.

The credit profile of the tenants we added was very attractive.

51% of the acquisitions are leased to tenants with investment-grade credit ratings.

These properties are leased to 19 tenants in 18 separate industries and 11 of the 19 tenants are new tenants for us.

Approximately 70% of the acquisitions were in the dollar store, wholesale club, food processing, and apparel industries.

And the acquisitions were well geographically diversified in 19 separate states.

Just under 70% of the acquisitions were comprised of our traditional retail assets.

The majority of the balance of the properties were distribution properties.

So through the third quarter of this year we've acquired 234 properties for approximately $718 million, at an average cap rate of 7.12%, which we believe is attractive as we continue to improve our tenant credit profile.

64% of the acquisitions year to date are leased to tenants with investment-grade credit ratings.

The average lease terms of these year-to-date acquisitions has been 14.3 years.

They're leased to 21 tenants in 19 separate industries and are located in 33 states.

77% of these acquisitions were comprised of our traditional retail assets and, again, the majority of the balance of the properties are distribution assets.

Let me spend a minute talking about the current status of the acquisitions market.

The market is as active as we've ever seen it in our company's history.

To give you an idea of that, year to date we've sourced $14.9 billion in acquisition opportunities as a company.

Last year during the entire year we sourced $13 billion of acquisition opportunities, which was our most active year ever for sourcing acquisitions.

About 60% of these properties sourced are leased to investment-grade tenants.

Now, while the market remains competitive, we're continuing to pursue a number of these opportunities and expect to close over $1 billion in organic property level acquisitions for 2012.

And of course, this would exclude our acquisitions that will be part of our merger with ARCT.

And looking forward, we really don't see a slowdown in acquisition opportunities.

There are a lot of sellers in the market for a number of reasons today.

And we continue to be engaged in a number of discussions with those sellers.

We remain optimistic relative to both our near-term and intermediate term acquisition opportunities.

Let me spend a second on cap rates.

As you may have noticed, the cap rates have contracted a bit more during the year.

However, we believe we'll end the year with average cap rates in the 7.25% area.

The investment-grade properties that we pursue are currently trading at cap rates in the low 6% to low 7% range.

And the non-investment-grade properties are trading in the low 7% to low 8% cap rate range.

Our investment spreads continue to be at historical highs, though.

Our year-to-date average cap rate of 7.12% represents 185 basis point spread to our nominal cost of equity which, again, is our FFO yield adjusted for our cost of raising equity.

That 185 basis points compares quite favorably to our average spread of 110 basis points over the previous 17 years when the vast majority of our acquisitions were on properties leased to non-investment-grade tenants.

In 2011, our spread to our nominal cost of equity on our acquisitions was 170 basis points, when 40% of the acquisitions were with investment-grade tenants.

So we have been able to improve our investment spreads to 185 basis points while continuing to move up the credit curve this year with 64% of our acquisitions being leased to investment-grade tenants.

So it's a great time for us to acquire at very attractive spreads while enhancing the credit profile of our tenant base.

Tom?

Thanks, John.

Obviously we're pleased with the acquisitions we've closed year to date and that are expected to close in the fourth quarter, and certainly where spreads are, as John mentioned.

We also think that we'll start the year off in 2013 faster than we did this year, given the transaction flow.

If you'll recall, a year ago the first quarter was fairly slow relative to closings.

And this is all on really the property by property or portfolios we're seeing here on a granular basis, individual properties, and really not part of any volume that comes from M&A.

If you look at the ARCT transaction, upon that close that would get us to about $4 billion in additional assets for the year.

And while that's been the news as of late, the $1 billion-plus in normal acquisitions for this year, as John mentioned, would be a record for the Company.

Mentioned last quarter -- and it still holds true and we think it will going forward -- that acquisitions will continue to play a big role in continuing to grow our revenue and AFFO, which is what will drive dividend increases.

And then, secondly, and equally important to us is adjusting the makeup of our portfolio as time goes on where we're moving up the credit curve.

And we've made good progress on that front again this quarter.

Paul talked about the balance sheet and access to capital.

Obviously we're in very good shape there, with plenty of dry powder to execute on acquisitions as they present themselves.

Obviously, the $1 billion credit facility is very helpful for that and that is fully available.

And, as Paul mentioned, we also have $160 million of cash on the balance sheet, so a lot of capital to do what we need to do.

Obviously, relative to permanent capital out there, the markets remain open and quite attractive.

Looking at the execution on the recent debt offering, obviously pricing is just absolutely outstanding and historic in the REIT industry and certainly for us on that transaction.

Equity is attractively priced and as is preferred and, given cap rates maybe at the 7.25% level for the year, spreads very attractive.

Relative to the guidance that we put out a month or so ago, there was no changes on that.

And 2012 guidance, excluding the one-time costs of the ARCT transaction, we're looking at $2.00 to $2.04 per share for the year.

Included in that, as Paul mentioned, is the $0.03 per share noncash charge from the redemption of our preferred earlier in the year.

And AFFO of $2.06 to $2.11 per share, which would be about 2.5% to 5% AFFO growth.

And, as always, that's our primary focus, as it best represents the recurring cash flow from which we pay our dividends.

On 2013 guidance, again assuming a 12/31 closing of the ARCT transaction, we're looking for $2.30 to $2.36 per share and AFFO of $2.31 to $2.37.

That'd be 9.5% to 15% AFFO growth for the year and, again, really is the focus, given we pay dividends out of that.

Speaking to dividends, we remain optimistic that our activities will support the ability to continue to increase the dividend.

As Paul mentioned, we increased it $0.06 in August and then did the regular quarterly increase in September.

And as most of you know, we've also mentioned that if we close the ARCT transaction, we'd probably raise the dividend about $0.13 a share.

Historically what we've done, for those that haven't been with the Company a long time, we raise the dividend in fairly equal amounts each quarter.

And then really looked in our August board meeting to see if a fifth, larger increase in the dividend is warranted in order to keep our payout ratio at about 85% to 87% or so of FFO, which is our target.

Our AFFO payout ratio is in that range now.

And obviously the AFFO growth for next year looks pretty attractive.

In the mid range of the guidance, that would likely get our AFFO payout ratio down around 83% or so by the end of next year, which is below where we target.

So at this point we'd anticipate 2013 to be another pretty good year for dividend growth also.

I think that's it relative to walking over the different pieces of the business.

And, Operator, if we can, we'll go ahead and open it up for questions.

Absolutely.

(Operator Instructions) Emanuel Porchman; Citigroup.

Looking at the distribution facilities that you acquired, I know, Tom, in the past you've spoken about looking at distribution sort of in parallel with retail.

Was that the case here?

Was there an overlap with your existing retail tenants that gave you comfort in buying those distribution facilities?

Actually, no.

The majority of the retail tenants, as you know, before three years ago were all less than investment-grade.

And our comfort level historically on retail is obviously having cash -- four-wall EBITDA cash flow coverage numbers and knowing the P&Ls of the stores we own.

And when we move into the distribution facilities you really don't have that.

So you're relying more on the real estate itself and what you're buying and how important it is to the tenant and their need to really use that particular facility.

And so for us also then, what we want to do is we want to be going up the credit curve when we're working on those type of properties.

And that's the majority of what we're doing.

So it's really going to the Fortune 500 or Fortune 1000 and approaching them relative to those distribution facilities and trying to buy ones that are either well priced and in very good areas for them to support their long-term activities, or perhaps they're right next door to a manufacturing plant for one of their main product lines.

So if you kind of look through the distribution facilities that we've bought in the last quarter, the tenants on those were, as an example, Whirlpool Corporation was one.

Another tenant was Proctor & Gamble.

Another one was PepsiCo.

Another one was, obviously, FedEx and another to Toro.

So, all very large investment-grade names, and that's generally where we're focusing.

And I don't think we own more than one or two distribution facilities -- and those we bought some time ago -- with tenants that are not investment grade.

Okay.

And then, looking at the ARCT transaction sort of, say that closes.

Does that change the way you approach acquisitions?

Do you then expand your net on what you're out there looking at?

I don't think it will materially change where we are right now.

As we've said, in retail there are areas that we've bought in the past that we just want to hold on, those we want to sell, and then a number that we still find attractive.

And then outside of that it's really distribution and a little manufacturing, and a little bit of office, but not much, and perhaps agriculture, but all investment-grade tenants is what we want to do there.

And that's where we're focused, so that's pretty much what we get in the ARCT transaction.

And so I would imagine that we'll stay right on that.

Hey, Tom, it's Michael Bilerman speaking.

(Inaudible) question just going to the ARCT transaction in a little bit more depth.

You're clearly aware that there's probably a little bit more investor frustration, at least on the ARCT side of the transaction, and some pretty vocal shareholders who effectively are going to vote no, as the current deal stands.

And I'm just curious as your sort of feelings towards that.

Clearly the proxy is out and everyone can read it, that you were the only bidder and that was the negotiated transaction that occurred.

But do you have a lot of accretion built into this deal for next year?

You've communicated a sizeable lift in the dividend.

I guess, do you sort of walk away if they vote no?

Well, obviously if there's a no vote in the transaction, yes, we would walk away.

We think -- and if you look at the proxy -- and I also want to say that, again, since it's in the SEC and there's likely to be some comments, we want to make sure we don't go in too much detail until we have a final and effective proxy.

But if you read the background section you can see that the negotiations were discussed over time.

And both parties kind of drew a line relative to valuation as to where they wanted to go.

And we weren't able to get there.

And then after they started trading that both of the equities moved in a fashion so we could put together a transaction.

But our feeling is that at the time that it was announced, it was around a 5.9 cap rate.

Today on price it's around 6.

It's a very good portfolio.

It's 75% investment grade.

It fits what we're trying to do strategically, very carefully.

But we think we paid a bit of a premium to capture this large portfolio, and did so with an attractive issuance of equity.

But for us, the price that we're paying here is, we think, a full price.

And, yes, we would walk away.

As we mentioned, we have $1 billion-plus in acquisition flow that's granular.

And we also have a great feeling about how next year is going to work out.

And so we would do that.

However, we do believe that the majority of the shareholders, once we have the final prospectus, the proxy, out we'll be able to engage in conversations and think we will get a yes vote on the transaction from both groups of shareholders, for whom we think there are very good benefits.

Is there any costs -- if there is a no vote, do you have to incur any sort of costs?

Obviously there were some costs of the transaction that you -- but what would that sort of -- is there any penalties or anything that we'd have to be mindful of?

Yes, I think it would be minor if there was a no vote by either party.

In our case I think we would have about $4 million that would be due us to pay for the fees of the transaction.

And we're figuring out exactly what those would be if there was a no vote.

But it's relatively close to that.

That would pay for the majority of it.

And that really wouldn't see a significant impact.

I think it's the same on the other way with that for us and a no vote, but I don't think there's much, if any, chance of that whatsoever.

And then I just guess you had raised a lot of unsecured debt capital, so effectively you'd be a little bit, I guess, overcapitalized from that standpoint relative to the transaction.

Yes -- we would not be actually, Michael.

We had obviously a very big quarter in acquisitions and we look for a substantial quarter in the fourth quarter, and we're running the number backwards to get to a little over $1 billion in acquisitions.

So really, with $160 million sitting in cash, we'll easily use that for closing properties in the fourth quarter.

And then it just means that the line would be fully available if we did not do the transaction.

And if we do the transaction, which we fully anticipate, we can do it on the line.

Okay, great.

Well, it's good to hear that you're going to stick firm on your exchange ratio and not try to engage in a self bidding.

Right.

Thank you.

Thank you very much.

Joshua Barber; Stifel Nicolaus.

You guys have covered most of my questions already.

Just one quick one.

I guess, getting to the enterprise value that you will be post ARCT, at least assuming that there will be a post ARCT, what would you say your minimum deal size is when you're looking in the acquisition market today, and how has that changed over the last couple of years?

It's really grown over the years.

We've always been more than willing to do a one-off transaction of a small nature and add it, and happy to do that today.

But over the years we've gone where $50 million back when we were $500 million in assets would be a 10% allocation to a tenant.

And that was kind of our threshold.

And sitting at $11.4 billion you could go out and do $0.5 billion transaction with a tenant and still retain under 5%, with an individual tenant.

And then, relative to a portfolio or additional M&A with a multiple-tenant portfolio it really gives us a lot of flexibility.

So the ability to do larger transactions is certainly enhanced by completing this merger.

Okay.

And one last thing -- you had mentioned some comments about CapEx and why [straight alignments] were a bit higher this quarter.

Would you expect some more of that, I guess, in the next couple of quarters, with Buffets and Friendly's releasing?

Or is that process mostly done at this point?

We're pretty well along the way of getting the majority of anything Friendly's or Buffets done, so there shouldn't be a lot there relative to CapEx on that.

Yes, CapEx overall, Josh, has gone up a little bit.

Historically we had virtually none.

Our current project run rate for this year and next year is about $6 million to $7 million total, which of course is on a $500 million-plus revenue portfolio.

So it's still a relatively small number, but a little higher than it has been in the past.

Some of that is investing in existing properties to assist in the releasing of those, as you've guessed.

But overall still the large portion of the portfolio or most all of it is more so triple net and where we're not responsible for those sorts of expenses.

Okay.

That's great.

Thanks very much, guys, and good luck.

R.J. Milligan; Raymond James.

Couple questions.

For going forward, for 2013, do you think the mix of retail versus nonretail, that 75/25, do you expect that to continue?

You know, it's going to be transaction driven, R.J. We think that's a very nice mix, but if it was 60/40, that wouldn't really bother us either way.

We're really out after those areas of retail that we can buy quite aggressively.

And if there was 100% quarter where it was all in retail, that'd be fine with us, too.

And looking quarter to quarter we're really not focused on trying to balance that.

But overall, if I had to guess, 75/25's not a bad number; 60/40's not a bad number.

In terms of the opportunity set, is there a larger opportunity set of acquisitions in the nonretail bucket and you're just choosing to pursue that 75/25 mix?

Or what do the opportunities look like?

I'll let John comment, but it's changing as time goes on as -- it's been interesting over the years.

In the mid-90s we entered the convenience store business.

And it really took us two, three years where everybody that was in that business knew we were out and acquisitive and we were really able to do accelerate.

Then we went in movie theaters; it was the same thing.

And so, now for really last year and this year, and in particular mostly this year, because most of what we bought in that area last year came from the ECM transaction.

We're now getting traction with people knowing that we're out there and we are buying this type of property, so our flow is increasing.

Yes.

So let me give you an idea for the distribution of property types within that transaction flow.

So, of what we've sourced of $14.9 billion year to date that I referred to earlier, about 60% of that is retail properties.

And the next largest chunk of that is distribution and industrial, at about 25%.

So that's how it shakes out.

But it does ebb and flow, depending on what the opportunities are, at any specific point during the year.

But that will give you a feel for what it's looked like year to date here in 2012.

Okay, thanks.

And, Tom, as part of that strategic review that you guys did a couple of years ago where you decided that you wanted to move up the credit curve, part of that, if I recall, was wanting to hedge yourselves against inflation and trying to put in contractual rent bumps or CPI bumps into the leases and increase the percentage of leases that you had with those bumps.

Now, with ARCT I'm assuming most of those don't have any bumps or CPI protections in them.

I'm just wondering how you thought about the tradeoff there for going up the credit curve, yet sort of taking a step back in terms of inflation protecting the portfolio.

Yes, a lot of their leases do have bumps.

But that's -- one of the most difficult things over the last few years has really been trying to build in full CPI into the leases.

And we've gotten up -- and I can't remember the exact number, but it's --

Over 20.

Yes, over 20%, Paul says, now that we've been able to do that.

But it is really a slog.

We've had 30 years here of declining interest rates and relatively tame inflation.

And across industries in the US the sellers, and particularly in retail, have gotten very used to not having big CPI components.

So that continues to be a battle on that situation.

Relative to going up the credit curve, the decision to go up the credit curve really was twofold.

One was thinking that retail may be a little tougher in the future, particularly in some segments.

But mostly we're just -- I think September 30th was the 31st anniversary of the 10-year getting up over 14% and starting its decline that's gone on ever since then, where we're now down to 1.88% I think I looked this morning.

And if you look at the average rate on a 10-year over the last 31 years, it's been about 6%.

So it was really going back, completely [underwriting] our whole portfolio.

And acknowledging that we were all kind of running downhill with less than investment-grade tenants during that period and that, as we looked going forward and the possibility of interest rates being higher, wanting to disengage from a few tenants that we think would be vulnerable in a rising interest rate environment, and move up the curve to protect against that.

Everybody's got their opinion of what the chances are of having much higher interest rates.

But we also think even if there was prolonged lower interest rates due to economic weakness, it's likely to be tough on the more levered people's business and likely that we would eventually see some credit spreads gapping out.

So either way, we think it's really a good idea to move up the curve.

And that was the primary reason behind that one.

And going forward, again, we're at 20% now.

Closing ARCT we'd be at about 34%, 35% and be very happy to wake up in four or five years and have that number 60%, 70%, 80% of the portfolio.

Okay.

So the acquisition's actually going to increase the percentage of the portfolio that has sort of the CPI bumps?

It is -- no, it's about the same.

Well, his comment going 20% to 35%, he was referring to the investment-grade portion.

Yes, sorry, investment grade, not the part with bumps.

I think it will keep us right about 20%, maybe a little less, little more.

Okay.

And then a quick question for you, Paul.

As we were just looking at our models and thinking about the proceeds to pay for acquisitions and the ARCT transaction, would you expect, say, a year from now leverage to be pretty similar to where it was a quarter ago?

Or how are you thinking about leverage and what's your target over the next year?

Yes.

As you know, our philosophy is go equity first, if you will -- two thirds common, the remainder really the debt and preferred side in the capital structure.

With this recent bond offering, as we speak and sit here today, our leverage I'd say is a little higher than what we'd like as kind of a longer-term run rate.

30% debt, 70% preferred -- we're prefer that to be 5%, 10% lower in terms of that portion.

So we will look to the common equity markets first as a form of financing over the next 12 to 15 months in terms of the balance sheet.

The other thing is, I think it was 1994, right, when we went public, that we said that we wouldn't want to be over 35% debt on the balance sheet.

And we've never gotten there.

And we had a discussion in our board meeting in August, just saying that remains, even though we're, gosh, 20 times the size that we were then.

But that we think is an appropriate balance sheet strategy.

And in the 20s, we don't mind at all either.

Okay, great.

Thank you, guys.

Craig Schmidt; Bank of America Merrill Lynch.

I was wondering, is there also a push for more investment-grade tenants within the retail space?

There is.

As a matter of fact, within retail we also have a higher percentage going up.

If you look in the top 15 in the press release, I think Family Dollar crept in there.

And we have had some transaction recently with several other investment-grade tenants in that space.

So we'd like to go up the curve wherever we can, both inside and outside.

So that's definitely the case.

And I don't know, John, if we have any other numbers there.

Do you remember for the year within -- I don't think we parsed it within retail, Craig, but a good part of the retail this year has been investment grade.

Okay.

Do you have to pay a lower cap rate for those investment grades, or is that an agnostic view?

You generally do have to pay a lower cap rate.

And almost like in the bond markets today, credit spreads are fairly flat.

And they do continue to be fairly flat in the net lease business, but it is lower.

As John mentioned, for an investment-grade you're kind of in the 6% to 7% cap rate; for less than investment grade, 7% to 8%.

But given cost of capital, when you look today, over 60% of what we bought this year so far and what we're targeting is investment grade.

But we're getting an average cap rate of about 7.25%.

It's really one of those funny times when you can go up the curve and still have great spreads.

I recall about 16, 17 years ago, Bank of New York very nicely gave me a couple days with their head of credit for Bank of New York, just to talk to him about credit and underwriting and all the rest of it.

And I remember sitting down and he said -- what are you trying to do?

And I said -- well, I want to increase our volume of acquisitions substantially.

I'd like to go up the credit curve.

And I'd like to have higher spreads between our cost of capital and our interest rate.

And he laughed.

He said -- so does every banker in the world who's lending.

But it's almost impossible to do.

And I look at this year and last year, given Fed monetary policy and that's exactly what happened.

$1 billion-plus in acquisition in each year and going up the curve substantially.

And the spreads between cost of capital and cap rate, as John went through, being some of the highest we've had, maybe 70 basis points over the average for our 17, 18 years we've been public.

Craig, slightly over 50% of the retail we purchased this year to date has been with retail tenants that have investment-grade credit ratings.

Okay.

I guess we're living in impossible times.

But sounds good.

Thanks a lot.

Yes, I'm not sure what it does for the economy and the world long term, but in the short term in the net lease business it's been fairly attractive for us.

Okay, thanks a lot.

Todd Lukasik; Morningstar.

Just a question on the capital structure.

And I know the preference has always been for the corporate unsecured.

And I think you've stated that the mortgages that are coming on the balance sheet with some of these acquisitions are -- you hope to pay those down as soon as possible.

But I'm wondering with the movement to nonretail and investment grade, and with some of the property values maybe being higher now that you're acquiring than maybe the average has been in the past, and also with the investment-grade tenants paying the rents, if your view has changed at all in whether or not there's a place for mortgages in the capital structure going forward or whether you'd like to stick with 100% corporate unsecured.

Sure.

Good question.

No, we continue to absolutely pursue the flexibility of dealing in the unsecured markets with the debt and keeping the balance sheet in line.

And the only mortgages that we have had to date are those where we bought a portfolio and it was really uneconomic in the short term to pay off the mortgage debt.

Anything we could pay off we will.

We've never put a mortgage on a property and we don't intend to going forward.

It will strictly be when we buy a portfolio.

And then as soon as it's economic to do so we would pay it off.

And we're very, very much committed and always have been to the unsecured market and that being how we finance the Company, along with perpetual preferred and common equity.

Okay.

Thank you.

Rich Moore; RBC Capital Markets.

You've mentioned before, Tom, that you expect about $50 million of acquisitions per quarter, which of course is what I have modeled for the next four quarters going forward.

But given that, it seems to me that there's something fundamentally changing out there that is bringing more product to market.

And I'm curious if you have thoughts.

Is that more retailers just, say, looking to monetize real estate?

Is that debt coming due?

Or what is bringing all this stuff to market?

It seems to be bigger than usual.

Is that correct?

It is.

And I think, as things usually are, we're always looking for one reason but it's a confluence of forces.

I think the downturn in the economy a few years ago and the credit squeeze scared the heck out of a lot of CFOs.

And they started looking at their companies and looking for more nontraditional access to capital and identified real estate as being once source for that.

And so I think that's a part of it.

Second, as you see more sale leaseback out there, other people observe and act towards it.

And then I think there's also a feeling that right now, with interest rates low, that this is a way to obviously lock in permanent, permanent capital over a very long period of time and using the real estate while still maintaining the ownership [of it] and the flexibility.

And so those are all coming together.

And the last part for me -- and you can add on if you want to, John -- is our size, really.

And the size of the net lease business is growing and it's becoming more visible.

And it's allowed us to go into places we hadn't before, particularly going up the credit curve into the Fortune 500 and that in and by itself through our efforts has caused us to see more product.

Okay, good.

Thank you.

Yes, that makes sense.

And then on the dollar stores, on the addition of the dollar stores category this quarter, is there a story behind that, first of all?

And I notice that Family Dollar is I think 2.5% and the total size of the space is about 3%.

So I'm guessing there's obviously more beyond Family Dollar in there.

But anyway, on the dollar stores?

Right.

As part of the strategic review one of the things we did is obviously take a look at the consumer.

And really divided up to upper income, middle income, lower income and then divide it further between discretionary and nondiscretionary spending to try and pick what retailers we wanted to be with.

And we think in kind of the middle income to lower income it's a good idea if you could be with nondiscretionary spending.

And even within that, that's really a stressed consumer, which I think leads retailers in that space today to need to have a really significant value proposition for the consumer.

And I think our movement into dollar stores is a reflection of exactly that.

We did target the industry.

We think we will have more and you'll see that grow over the next few quarters.

By the way, it's the same thing with the warehouse club stores that you also see has come in there.

And both have that value proposition and that's why we upped our investment there.

You look at wholesale clubs, I think in this quarter it was around 2.8%.

That's BJ's and there's going to be another one coming in there.

And then in the dollar stores we're at 3 and that's Family Dollar and Dollar General and they've both been added to the portfolio, both of those investment-grade tenants.

And we expect -- we'd like our allocations to grow if we can find additional opportunities.

Okay.

So you're looking beyond Family Dollar and Dollar General as possibilities?

Or really those two are the targets?

You know, once again, we want to go up the credit curve and both are investment-grade, so they're very attractive to us.

Yes, I got you.

Very good; thank you guys.

Tom Lesnick; Robert W. Baird.

Just a quick question.

You mentioned G&A expense would be about $36 million this year.

How should we be thinking about G&A expense going forward, presuming the ARCT deal goes through?

Our estimate for next year, I can give you a number, is about $42.5 million, is kind of what we see in our model right now.

That's some preliminary work on the budget for next year and that sort of thing.

That does assume ARCT closes end of this year.

And that would represent about 6% of our total revenues for next year, kind of, again, on a preliminary budget basis.

So from an overall ratio we see G&A going down significantly as a percentage of total revenues.

Because as we've mentioned, we don't see any material increase in G&A at all relative to the ARCT acquisition.

All right, great.

Thank you very much.

Thank you.

Ladies and gentlemen, this concludes the question-and-answer portion of Realty Income's earnings conference call.

I will now turn the call over to Tom Lewis for concluding remarks.

Please go ahead.

Thank you, Operator, and thank you everybody.

It's, with an hour on the call, a little longer than we normally do and we appreciate your patience.

We look forward to getting a final and effective prospectus in the near future and getting that out.

And we'll have additional discussions on the ARCT transaction.

And we'll now focus on making the fourth quarter another successful quarter.

And thank you very much for your attention.

Thank you, Operator.

Ladies and gentlemen, this does conclude our conference for today.

If you would like to listen to a replay of today's call, please dial 303-590-3030 or the toll-free number of 1-800-406-7325 and enter the access code of 4569429.

Thank you again for your participation and you may now disconnect.