Realty Income Corp (O) 2012 Q4 法說會逐字稿

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

Welcome to the Realty Income Fourth 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 being recorded today, Thursday, February 14, 2013.

I would now like to turn the conference over to Mr. Tom Lewis, Chief Executive Officer of Realty Income.

Please go ahead, sir.

Thank you, Katya, and good afternoon everyone.

Welcome to our conference call, and as Katya mentioned we'll go over the fourth quarter and our results for 2012, and a bit about what's happened since year end.

In the room with me today is Gary Malino, our President and Chief Operating Officer; Paul Meurer, our Executive Vice President and Chief Financial Officer; John Case, our Executive Vice President and Chief Investment Officer; and Tere Miller, our Vice President of Corporate Communications.

As I am obligated to do, I'll say that during this conference call we 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.

We will disclose in greater detail in the Company's Form 10-K the factors that may cause such differences.

And as is our custom, Paul, perhaps you could begin with an overview of the numbers.

Thank you, Tom.

As usual, I will walk through our financial statements briefly, and provide some highlights of our financial results for the quarter, and where appropriate for the year as a whole, starting with the income statement.

Total revenue increased 16% for the quarter and for the year, and our revenue for the quarter was approximately $130 million, or about a $520 million annualized run rate at year end.

This increase reflects positive same-store rents, but more significantly it reflects our growth from new acquisitions over the past year.

Pro forma for the ARCT acquisition completed in January, our current annualized total revenues as of 12/31 are now $712 million.

On the expense side, depreciation and amortization expense increased by about $8.6 million in the comparative quarterly period, as depreciation expense obviously has increased as our property portfolio continues to grow.

Interest expense increased in the quarter by about $6.1 million, and this was due to the $800 million of bonds that were issued in October, as well as some credit facility borrowings during the quarter.

On a related note, our coverage ratios both remain strong, with interest coverage at 3.6 times and fixed charge coverage at 2.7 times.

General and Administrative, or G&A expenses in the fourth quarter were approximately $10 million, and $38 million for the year.

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

Also, because we added some new personnel; and our proxy process last Spring was more expensive than usual.

We ended up expensing $2.4 million of acquisition due diligence costs during the year.

Our employee base grew from 83 employees a year ago to 97 employees today; however our total G&A was still less than 8% of our total revenues.

Property expenses were just under $1.7 million for the quarter and $7.3 million for the year.

These expenses historically have been primarily our carry costs associated with properties available for lease; however, our 2013 property expense estimate is higher, at about $12.5 million, as we have recently purchased more double net properties, whereby we are responsible for some of the property maintenance costs.

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

They were only $215,000 for the quarter and $1.4 million for the year.

ARCT merger-related costs -- obviously, this line item refers to the costs associated with the ARCT acquisition.

During the fourth quarter we expensed approximately $2.4 million of such costs; and for all of 2012, we expensed just under $7.9 million.

Income from discontinued operations for the quarter totaled $3.6 million.

This income is associated with our property sales activity.

We sold 14 properties during the quarter for $16.3 million.

Just a reminder that we do not include property sales gains in our FFO or in our AFFO.

Preferred stock cash dividends totaled approximately $10.5 million for the quarter, and this increase compared to last year reflects our issuance as a preferred F stock earlier this year.

Excess the redemption value over carrying value of preferred shares redeemed refers again to the $3.7 million non-cash redemption charge in the first quarter of last year associated with the repayment of our preferred D stock, with proceeds from our new preferred F offering at that time; and reminder of course that the replacement of this preferred D stock in our capital structure did save us about $1 million cash annually.

Net income available to common stockholders was about $28.5 million for the quarter.

Reminder that our normalized FFO noted here simply adds back the ARCT merger-related costs to FFO.

We believe normalized FFO is a more appropriate portrayal of our operating performance, and it is consistent with our public FFO earnings estimates and the First Call FFO estimate that analysts have published on us.

Normalized FFO per share was $0.56 for the quarter, a 9.8% increase versus a year ago and $2.02 for the year, a 2% increase versus last year.

Adjusted funds from operations, or AFFO, or the actual cash we have available for distribution as dividends, was $0.55 per share for the quarter, a 5.8% increase versus a year ago, and $2.06 for the year, a 2.5% increase versus last year.

Also you'll note that in our press release, we did affirm our same earnings estimates for 2013, which were previously disclosed last month when we were finalizing the ARCT transaction.

As you know, we also have increased our cash monthly dividend significantly over the past year.

In addition to our regular quarterly increases, we did a $0.06 annualized increase last August.

This month, we have a $0.35 annualized dividend increase.

We've increased the dividend 61 consecutive quarters and 70 times overall since we went public over 18 years ago.

Our current monthly dividend is now just over $0.18 per share, which equates to a current annualized amount of just over $2.17 per share.

Our estimated AFFO dividend pay-out ratio for 2013 is about 91%.

Briefly turning to the balance sheet, we believe we have continued to maintain a conservative and safe capital structure.

In October, as you know, 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.

At year-end, our $1 billion acquisition credit facility had a balance of only $158 million.

However, we did utilize our credit facility for the cash portion of our ARCT acquisition in January, which then increased our credit facility balance to about $700 million.

Our credit facility does have a $500 million accordion expansion feature above the $1 billion amount.

Our current total debt to total market capitalization is 32%, and our preferred stock outstanding is only 5% of our capital structure.

Our only bond maturity over the next two-plus years is a $100 million bond maturity in March of this year.

We do plan to raise some new capital during the early part of this year.

Use of proceeds will be to repay our credit facility borrowings, and thus free the facility up for further acquisition financing this year.

In summary, we think our overall balance sheet remains healthy.

We continue to enjoy excellent access to the public capital markets.

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

Thank, Paul.

As is our custom, I'll just kind of run through the different segments of the business, and let me start with the portfolio.

Once again, the portfolio continued to generate very consistent cash flow in the fourth quarter.

Generally, the tenants are doing very well; no issues arose with any of the tenants during the fourth quarter, and we look for that to be the case here in the first quarter.

Also, there's nothing out there that we're looking at.

On our calls, normally what I'll do is talk about some of the metrics relative to the portfolio, and how they moved and why quarter to quarter and year to year.

As we've added in this release the supplemental disclosure on the closing of ARCT, post year-end I'll also mention on a pro forma basis what that does to some of those metrics, and give everybody a flavor of how we sit today.

Then obviously all of those numbers will be integrated into our first-quarter results a little later into the year.

At the end of the quarter, our largest 15 tenants accounted for about 47.1% of our revenue; that's down 270 basis points from the same period a year ago.

Now on a pro-forma basis post-ARCT, the Top 15 dropped from 47.1% to 42.1%, or another 500 basis points.

Obviously, the acquisition efforts relative to both normal acquisitions and ARCT has had a significant impact in reducing concentrations in the portfolio, and that obviously is included in our largest 15 tenants.

Cash flow coverages on the retail properties that we have in our Top 15 tenants continue to be very strong, at about 2.5 time four-wall EBITDA rent coverage; so the portfolio continues to operate well there.

From an occupancy standpoint, we ended the fourth quarter with 97.2% occupancy and 84 properties available for lease out of the 3013 we own.

That occupancy is up 20 basis points from the third quarter, and up 50 basis points from a year ago.

On a pro forma basis, post-ARCT, that increases another 40 basis points to about 97.7% occupancy as we sit here today.

Back on the year-end numbers before ARCT, as I've mentioned the last few quarter there's kind of three ways to calculate occupancy -- the one I just used which is on vacant buildings versus occupied buildings calculation, that's 97.2%.

If you ran it on vacant square footage versus occupied it would be at 98.2%.

Then the third way uses previous rent on vacant properties against total rent, including the previous rents, and that would be at 98.5%.

All three are very healthy, and all three would be higher under the ARCT calculations.

Same-store rents on our core portfolio increased 0.4% during the fourth quarter and 0.1% year-to-date.

As most of you recall, same-store rents had been off a little bit the first three quarters, primarily as a function of a couple of tenants.

Those are moving out of the numbers, so it went positive in the fourth quarter in volume enough to make it positive for the year overall.

Looking forward, we think same-store rent growth should accelerate and move to a more normalized level than the 1%, 1.5%-plus range in each quarter in 2013, and we think that will start in the first quarter.

With all these acquisitions, obviously the diversification of the portfolio continues to widen substantially.

At the end of the year we were at 3,013 properties.

That's up 175 properties from last quarter; then with 44 different industries now represented in the portfolio, with 150 tenants in 49 states.

On a pro forma basis, adding in ARCT, it's 3,528.

That's up another 515 properties in 48 industries, 202 tenants, and 49 states.

Industry exposures are well diversified, and with the closing of the transaction, I think specific exposures in certain industries have declined quite a bit, which I think is really meaningful when looking at the portfolio.

I'd note that in some of our larger segments, convenience stores as an example is our largest industry.

At 12/31 that was 14.9% of revenue, down 140 basis points from last quarter, and 230 basis points year over year.

Then pro forma, that drops another 330 basis points, so down to around 11.6% of rent, so a substantial reduction.

Restaurants, and here I'll just combine both casual dining and quick service, are now at 12.4%.

That's down 80 basis points in the fourth quarter and 400 basis points for the year.

Now pro forma drops another 220 basis points to only 10.2% of rent.

Importantly, and I've talked about this before, for where we want to take the portfolio, that gets the casual dining portion on a pro forma basis down to only 5.6%, versus 15% of the portfolio a few years ago.

That also takes theaters at 12-31 to 8.7%, and that's down 80 basis points.

Then pro forma, it drops to 6.6%.

So we continue to decrease concentration in some of these larger segments, which is very good progress there.

We've also increased the percentage of revenue that is generated from several of the industries on a pro forma basis that we're targeting -- transportation services moves up to about 5.7%.

Almost all of that comes from our investments in FedEx.

Drug stores increases to 6.6%, mostly through additions of additional investments with both Walgreens and CVS.

Then dollar stores now increases to about 5.6% of rent, and those investments are primarily with Family Dollar and Dollar General.

The majority of where we added, we believe, in those industries are with investment-grade tenants and under long-term leases.

The largest industries on a pro forma basis, then, will be the C-stores at 11.6% -- that's the only industry over 10% now; drug stores at 6.6%; theatres at 6.4%; transportation services at 5.7%, and then the dollar stores and casual dining both at 5.6% of revenue.

All then other industries come in below 5%.

For those of you who have been with us for a while looking back three to four years, that's a pretty meaningful reduction.

If we look at it from an individual tenant standpoint, the recent acquisitions in ARCT make a lot of changes there also.

The largest tenant now is FedEx at 5.5% of rent.

Then LA Fitness, who we like a lot at 3.9%; Family Dollar and AMC both 3.5%; Diageo, which are our wine operations, and BJ's both at 3.3%; and then that takes everybody below 3%, so a reduction there, too.

I mentioned our largest 15 tenants are 42.1% of rent pro forma; and when you get to the 15th largest tenant, we're now down to about only 1.6% of revenue, so very well diversified.

Also, that's the case with geographic diversification -- from a geographic diversification standpoint.

Average remaining lease length on the portfolio is healthy at about 11.2 years.

That's up a bit.

Let me kind of circle back to the top 15 tenants for a minute, and take a look at that group post the ARCT acquisition.

In 2008 and 2009, as most of you know and we've talked about on a lot of our calls, we went through a strategic planning evolution where we decided to make some adjustments on a go-forward basis in the portfolio, and really just started implementing that in 2010.

Kind of the themes we were looking at is targeting certain retail industries relative to the consumer base they serve, and really looking at kind of is it upper-income, middle-income, or lower-income consumers; and then trying to differentiate between those retailers that sell discretionary goods and services versus those that are non-discretionary; and trying to focus mostly towards retailers who focus on non-discretionary items.

Secondarily, when working with middle- or lower-income consumers, to make sure that the retailers we're targeting really have a deep value proposition.

Then thirdly, trying to stay with the long term theme of convenience and necessity.

Then as you can see pretty clearly right now in the makeup of the top 15 on a pro forma basis, Family Dollar, Dollar General, BJ's, Walgreens and CVS are all now in the top 15, so that matches with those themes.

We also decided to pursue acquisitions outside of retail.

That's now a little over 22% of our revenue, and FedEx with being the largest one; and virtually all of those leases and properties are long-term leases to very large tenants with investment-grade ratings.

Then as a general theme, also both for retail and outside moving the portfolio up the credit curve and working more and more with investment grade tenants.

If you look at the top 15, five of the top 15 tenants are now rated investment grade versus zero three years ago.

With about 34% of our overall revenue on a pro forma basis now coming from investment grade tenants.

If you include leases with the subsidiaries of investment-grade tenants, that's about 37%.

We really think doing that, along with portfolio sales, that those initiatives -- be it through added diversification by industry or tenant or geography or whether it's tenant credit or the industries we're targeting and investing in -- we believe the quality of the cash flow generated by the portfolio has been significantly enhanced over the last three years, and we'll continue to pursue those initiatives, and very pleased so far.

Let's move on then to first to property dispositions that continues to grow a bit.

During 2011, we sold 26 properties for $24 million.

2012 we sold 44 for $50 million.

For 2013, we'd anticipate to be at least $100 million, and we think we'll get more than half of that done in the first half of the year.

We may be able to exceed that number going forward, and that will be a theme that we just slowly move ahead.

The focus there is really trying to improve the credit quality of the portfolio and decrease our exposures in certain industries.

To date that's been primarily in restaurants, primarily casual dining, which as I mentioned continues to decline as a segment in the portfolio.

Then we also have targeted convenience stores for a number of sales, and then any properties with tenants that tend to be smaller and we think are more exposed to a down-turn in the economy.

The focus there is really trying to reduce exposure to this discretionary purchases from middle-, low-income consumers.

If you watch them today, there's a lot of these people in this country living paycheck to paycheck and without savings.

Any movement or economic event really has an impact on them on a current basis relative to their expenditures.

We're trying to move away from that area and either have a deep value proposition, or as I said, stick with basics.

Let's move on to property acquisitions.

2012, as we noted, was a record year for acquisitions, and that's before we get to the ARCT transaction.

We continue to be very active moving into 2013.

Let me turn it over to John Case, who is our Executive Vice President and Chief Investment Officer, and he will walk you through the year and where we see things going.

John?

The fourth quarter was a very active quarter for us for acquisitions, as you know.

We acquired 189 properties, investing approximately $447 million in acquisitions.

This was our third-most acquisitive quarter in our Company's history, finishing only behind the fourth quarter of 2006 and the third quarter of last year.

The average cap rate on the fourth quarter acquisitions was 7.4% at an average lease term of 15 years.

Credit profile of the tenants we added was quite attractive.

63% of the acquisitions are leased at tenants with investment-grade ratings.

These properties were leased to 13 tenants in 10 separate industries.

Five of the 13 tenants are new tenants, and dollar stores and health and fitness were the largest industries represented.

These properties were geographically diversified, located in 27 states, and 80% of the fourth-quarter acquisitions were comprised of our traditional retail assets.

For the full year 2012, that brought us to $1.16 billion in acquisitions activity, comprised of 423 properties.

This is the most we've ever completed in a calendar year, and it surpasses our previous record in 2011 of $1.02 billion.

The full-year acquisitions were done at an average cap rate of 7.22%, with the weighted average lease term of just over 14.5 years.

We continue to improve our tenant credit profile, as Tom has alluded to.

Last year, 64% of the acquisitions were leased to tenants with investment-grade ratings.

They were leased to 29 tenants in 23 separate industries.

Dollar stores, wholesale clubs, and health and fitness were the largest industries represented in last year's acquisitions.

We were able to add 16 new tenants in four new industries.

The properties were located in 37 states, and 78% of the acquisitions were comprised of our traditional retail assets.

About 80% of our acquisitions activity last year was comprised of larger portfolio transactions.

These are transactions that are $75 million or greater; so those larger transactions are really what drive our volume from year to year, as you know.

Let me spend a few minutes talking about the acquisitions market today.

It continues to be as active as we've ever seen it.

In 2012, we sourced $17 billion in acquisition opportunities.

Now this sourcing number is everything that comes in our door in terms of acquisitions opportunities that meet some of our investment parameters; so we analyzed this and worked on a fair amount of it, and eventually we ended up closing the $1.16 billion.

The $17 billion was also a record year for acquisitions sourcing and transaction flow for us, surpassing 2011, when we sourced $13 billion in acquisition opportunities.

Of the properties we sourced last year, about 55% were leased to investment-grade tenants.

Today the market continues to be competitive.

Looking forward, we continue to see an active pipeline of opportunities.

There are a lot of sellers in the market that are attracted by the attractive pricing, and significant transaction volumes we're seeing in the net lease sector today.

We're engaged in numerous discussions, and we're currently projecting $550 million in acquisitions at an initial yield of 7.25% for 2013.

But the ultimate amount we complete will be determined by our success on the larger portfolio transactions, as we've discussed before.

Let me spend a moment on pricing.

Cap rates are holding steady to where they were in late 2012.

Investment-grade properties range from the low 6% to low 7% range.

Non-investment-grade properties range in the low 7% to the low 8% cap rate range.

Cap rates have continued to decline over the last few years.

Of course, last year they averaged 7.2%.

In 2011, they averaged 7.8%; and in 2010, 7.9%.

This is a function of the declining yield and interest rate environment, and also more importantly, our working up the credit curve and doing substantially more acquisitions with investment-grade tenants.

Our investment spreads in margins, however, continue to increase and are at historical highs.

Let me spend a moment on this.

Our 2012 average cap rate of 7.22% represents a 190-basis-point spread to our nominal cost of equity; and again, that's our FFO yield adjusted for the cost of raising the equity.

That 190 basis points compares favorably to our average spread of 114 basis points over the previous 19 years of our Company since our IPO, when we acquired assets primarily leased to non-investment-grade tenants.

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

So we improved our spreads by 20 basis points year over year, while we increased our percentage of acquisitions leased to investment-grade tenants from 40% in 2011 to 64% in 2012.

This was a very attractive outcome for us.

Now as you know, we also track our cap rates relative to 10-year Treasury yields.

Since our IPO in 1994, our cap rates have averaged about 475 basis points over the corresponding 10-year Treasury yields.

In 2012, our cap rates averaged 545 basis points over the average 10-year Treasury yield, with 64% of our acquisitions leased to investment-grade tenants.

In 2011, our cap rates averaged 505 basis points over the 10-year Treasury yield, with 40% of our acquisitions again leased to investment-grade tenants.

So we've been able to improve our investment spreads based both on our nominal cost of equity and 10-year Treasury yields, while continuing to move up the credit curve in 2012.

Tom?

Thanks, John.

We're obviously very pleased with acquisitions closed for the year and where spreads are given increasing credit, as John said, and remain optimistic about additional acquisitions this year in what is a pretty robust flow of opportunities to look at right now.

I would like to note the timing of the acquisitions that came in for 2012.

It's kind of interesting to examine.

In the first quarter of last year we acquired a grand total of two properties for $10.7 million.

In the second quarter we acquired 145 properties for $210.8 million.

Third quarter acquired 87 properties for $496 million, and then in the fourth quarter acquired the 189 properties for $446.5 million.

Couple of thoughts on that.

Our acquisitions -- and we've talked about this over the years, but for anybody new -- tend to be lumpy.

That was the case in 2012, and we think that will continue to be the case quarter over quarter.

I wouldn't look at that as a trend line.

They tend to bounce around during the year.

It's also ultimately -- the volume, as John said, is a function of how many larger transactions we close, or don't close.

So far this year we think the $550 million we're using for planning purposes is the most we want to model this early in the year, even though we think at this point the first half of 2013 will be stronger than the first half of 2012; but we'll adjust that as the year goes on.

But that's what our guidance is based on, and again the big transactions are really going to drive that.

The other ongoing observation is that acquisitions tend to accelerate late in each quarter, and certainly later in the year.

That was again the case in 2012, with $942 million of the $1.16 billion coming in the second half of the year, and that means a couple of things.

The first is the majority of the revenue and FFO from 2012 acquisitions will manifest itself here in 2013, and that's pretty typical.

It also means we bought and closed on 276 properties for $942 million in really the last five months of the year, and that was at the same time that we were working on and preparing for the closing of the ARCT transaction with another 500-plus properties.

I'd really like to take a second and give credit to our staff, particularly acquisitions, and legal and accounting teams for their efforts over the last few months of the year when the productivity, to say the least, was really outstanding and the hours put in were long.

We've talked a couple of times over the last few years about working on our systems and adding staff to handle additional growth, which we have been doing for a couple years.

I'll tell you, doing that really paid off and allowed us to process that additional volume and move to efficiently integrate it into our systems and portfolio.

I would note, though, that we will need to do that again to continue to grow at a substantial rate.

Gary Malino, our President and Chief Operating Officer and I will spend a fair amount of our time this year focused on that again on peoples and system.

Let me talk specifically for a moment about the ARCT integration process.

That's going very smoothly, as a great deal of the work was done during the solicitation process on the transaction, but it is a huge volume of work.

The tough stuff that was done really as we went along and are mostly done are the loan assumptions, the entity consolidations, lease reviews, property reviews, title, and accounting is pretty much finished.

We're really just down to a few outliers here and there, so I think I'd characterize the integration overall as about 80% to 90% finished here, just a couple of weeks after closing.

We were helped significantly by the fact that both companies utilize the same software platform, which really helped the integration.

Then also, as you'll recall on this, there were no Management or employee integration issues that came with the transaction.

The majority of what is left is primarily additional data entry and some merging of files and then some remaining lease compliance work.

We think we can get almost all of it, if not all done here in the first quarter.

Anyway to tie up acquisitions, we think both on a granular basis and on larger transactions, it will continue to really be acquisitions that's going to drive the revenue and play the largest role there in ARA/AFFO and our dividends, and certainly in the efforts to make ongoing change in the portfolio.

To put it in perspective relative to those changes, the last 36 months or so we've acquired about $6 billion of property including ARCT; $3.6 billion, or 60% of it, is in retail; and most in sectors that we're targeting and we think will continue to perform for us in what's been a pretty tepid retail environment.

$2.4 billion, or 40%, is outside of retail, in sectors and with very large tenants we think we'll do fine; and then of the $6 billion, $3.8 billion, or 63% was done with investment-grade tenants.

A good measure of the rest of the acquisitions all were also up the credit curve from where the portfolio stood if you go back four or five years, so good progress on that planned.

The other side of that is also funding these transactions.

In funding them the last three years, we've executed four equity offerings that generated about $1 billion in proceeds; and then in the ARCT transaction did a direct issuance of about $2 billion of equity, so there's about $3 billion of issuance.

We did as you recall last year about a little over $400 million in perpetual preferred, about $1.12 billion in investment-grade-rated bonds and notes that we put out, and assumed $710 million in mortgages, most of which we plan to pay off in the next few years; and then generated about $100 million for property sales, so about $5.3 billion of capital on that $6 billion in acquisitions.

Relative to the balance sheet and access to capital, we're in pretty good shape, as Paul mentioned.

We do have dry powder to close acquisitions.

The $1 billion credit facility, with a $500 million accordion is very helpful in that; but obviously, and as Paul alluded to, given the closing of ARCT, and the balance on the line, we'll look to access additional capital.

Equity is attractive here as is debt and preferred, and they are all available and the rates are good.

For those of us who followed us a while, I think we'll want to keep the balance sheet conservative, and so the mix of capital should remain pretty similar relative to debt equity and preferred to where we've been for a number of years now.

2012, good year as I mentioned; a lot of activity that will accrue to our benefit this year.

Paul mentioned we're keeping with the FFO guidance at $2.32, $2.38; that's 14.9% to 17.8% growth and AFFO of $2.33 to $2.39, which is 13.1% to 16% growth.

Last comment will be on dividends.

Obviously the last six, eight months have been active, with substantial increases in the dividend approaching around $0.42 a share, and we remain optimistic that our activities will support continued dividend increases during 2013.

I appreciate everybody's patience, but I think we got to most of it.

Katya, we'll now open it up to questions.

Thank you.

(Operator Instructions)

Our first question comes from the line of Emmanuel Korchman.

Please go ahead.

Just given John's comments earlier on the call about an attractive environment for sellers and pricing staying flat to let's call it a little bit richer than it's been over the last couple years, why aren't you selling more into it?

I mean, $100 million of dispositions, especially as you try to ramp up your investment-grade proportion of the portfolio, seems like it's a low number?

Well, I'll note it is accelerating; but you're right, and we would like to do more.

But one of the things John mentioned is about 80% of the acquisitions are in large transactions, and about 100% of the sales are in one-off transactions and rather granular.

If you look at what we've been trying to sell with C-stores and also casual dining restaurants, those are fairly small numbers, so it is a fairly labor-intensive operation.

We also probably would have had a higher volume this year, but we did have a big block of properties, probably another $50 million, $60 million that we just started to put on the market, and then some M&A activity with the tenant started; and it turns out we are getting an upgrade in some of the credit, and may not want to sell it.

So I agree, we would like to accelerate it.

It is a good market to do it in to, and if we can go well past the $100 million, we would like to do it.

Got you.

Then I think you touched on this earlier, I might have missed it.

The 0.1% same-store growth, can you first of all clarify if that's GAAP or cash?

Then I think you said that would accelerate as some tenants get pulled out of the mix.

Maybe you could just repeat that for me?

Sure.

It was 0.1% for the year overall, and 0.4%.

That is cash, not GAAP.

Normally, we'll run from 1% to 1.5%; and if you recall at the start of last year, we had two tenant issues, friendlies and buffets, where we did have some rent reductions.

During the year we disclosed both what it would be without that and with it.

With it for the year that's how you get to that 0.1% number, but a lot that burned off in the fourth quarter.

Absent that, I think same-store rent growth this year would have been 1.3% to 1.5%, somewhere in there.

With that burning off and the way the leases are structured, no tenant issues, we really anticipate the first quarter will bounce back closer to 1.5%, and then during the year run between 1% to 1.5% same-store rent growth.

Perfect.

My last question, I think you mentioned something about double net properties?

Maybe you could kind of help me figure out what that would be?

Sure.

It's a large portfolio, so there's a lot of everything in it.

For the most part it's triple-net lease, but in some of these properties that we buy the lease structures, particularly if it came from a developer, may be different.

It may be taxes, maintenance, insurance, but we may have roof responsibilities, and it's a new roof down the line; and there could be some other things that are in there.

When it's not triple, we just call it double, but it's probably more like 2.75% or 2.5%.

Anybody else want to add in to that?

No, that's right and most of it is on the little bit of property maintenance responsibilities.

But it typically wouldn't be anything outside of that, so you wouldn't be responsible for taxes or anything more major than (multiple speakers)?

That can happen from time to time, but that's not -- primarily not the case with most of the non-full triple-net stuff that we own.

It's primarily just responsibilities with regard to roofing and parking on 90% of those.

Right.

And they're a minority of the properties, but we think it's important to bring it up that if you see a little bit of property expenses, that's where it's coming from, but we don't see a huge acceleration.

But otherwise they're similar to the rest of your portfolio in being single-tenant, large properties?

Yes, absolutely.

And we've had these issues over the years on an ongoing basis.

It's just a little larger now, so we brought it up.

Thank you guys.

Our next question comes from the line of Joshua Barber.

Please go ahead.

Hi, good afternoon.

Tom and John, as you were mentioning that increasingly more and more of your regular acquisitions are on investment-grade properties, I'm wondering why a lot of those tenants are increasingly looking at net lease financing, especially given that they should have other credit availabilities that should be there.

It used to be, I guess the tradeoff for a lot of the tenants was the high yield market or nothing, but -- or net lease financing; but I'm wondering why more and more of those are looking at net lease financing, given the absolutely high coupons that seem to be out there, as opposed to other sources of financing.

Can you maybe walk us through that a little bit?

Yes.

There's always been, I think, in retail -- which is the smaller preponderance of it -- if somebody is really trying to roll out over time using net lease financing relative to their new unit construction; so that's been around, you've particularly seen it in the drug store segment, so it's become kind of normal and then crept around more in retail.

Sometimes it's with people on the Street really putting some appreciate you on companies to look at their balance sheet and try and unlock some value.

As you know, there's a lot of those discussions today going on around the country on the Opco/Propco side; and when you get those discussions going, even if people don't do it then they start looking at what's on the balance sheet and start running the numbers relative to their return on investment and other areas.

I think it also started just happening a little bit going back to 2008, 2009, where even some very strong credits started looking at some issues relative to financial flexibility.

Coming out of that, started thinking about real estate a little bit.

Traditionally it was less than investment grade.

It was really early 2000, 2001 we started working a lot with private equity and bringing that up, but it's a very common discussion now on the street relative to looking at the real estate and using it.

If you get to the kind of Fortune 500 and Fortune 1000, a lot of their real estate decisions are outsourced with a group of developers, and very often there's just a decision when working with the developer that they're not going to keep those assets, and some of them come off that way.

But I think there's just more and more talk going on about what's on the balance sheet, and how you provide flexibility and use it.

We haven't seen it like this relative to those discussions, particularly in the investment grade, for as long as I've been doing this.

Okay, that's very helpful, thanks.

Especially after the Diageo acquisition a couple of years ago, and as you mentioned with increasingly a greater number of REITs out there with the Opco/Propco structure, is that something that you guys would look at with increasingly different asset classes that are out there, or would that be a lot less likely to happen?

Yes, it's very interesting.

There's an awful lot of discussion, and we've had a few companies announce that they're either looking at it or are going to do it.

Then there's been some movement in their equity, and that always causes bankers and lawyers and accountants to have more and more discussions, and that's the phase it's at right now.

Then the question is will they get done, and if they get done, what will a single tenant REIT trade at; and are traditional REIT investors going to accept that, or is it going to trade at a higher yield?

If a bunch of them get going, then typically the first ones probably do pretty well, and then you have to see.

But relative to what it means to us, I think from a tax standpoint for most of those to be done on a tax-free basis more than 50% of the equity has to remain with the Company spinning off, and that has to happen for a couple of years; so it would take a bunch of those A, happening and B, a couple of years going by, and then C, probably valuations not meeting expectations before there would be some opportunities.

Given the size of the portfolio now, there might be some places where we could invest.

If all of that happened, given our size, it really wouldn't hit massive concentrations.

Absent that, we just think it's positive that again the discussions are going on in board rooms around the country about how you can add value using the real estate, and I think it will accrue to our benefit -- how much, we just don't know.

Right.

I think the single-tenant concept does concern a lot of people, but if that was a 2% tenant exposure for Realty Income, I think a lot of people may just think about that differently?

Perfect then, if it is an investment grade tenant or somebody we really liked and assets that were special, you could also make that 5% and 6%; because if you just look, obviously FedEx does get their real estate off balance sheet, that's 5.5%.

We could take those on, and I think in larger numbers as we get larger, but we'd just have to see what they are.

Okay, great.

Nothing in the near term, by the way.

Okay.

Thanks very much.

Our next question comes from the line of Paula Poskon.

Two housekeeping questions.

First, apologies if I missed this in your earlier remarks.

What was the acquisition expense in 4Q, aside from the ARCT costs?

$2.4 million for the year, and I just don't have my finger tips on what it was in the fourth quarter.

I'll follow-up offline.

Okay.

Secondly, what was the difference between the impairment amounts on the income statement versus the FFO calculation?

Where are you looking?

The first was provision for impairments on the income statement of $2804, and then the add back in the FFO calculation was $4472.

I'm just wondering what that difference represents.

I recognize it's a small amount.

Right.

Trying to find where you're looking in the add back.

Paula, how about those are two we'll go figure out.

Yes, I'll get that to you off line.

Fine, no problem.

Then just sort of a bigger picture just to stay on the theme of the acquisition environment.

Tom, I appreciated your color in your prepared remarks on the lines of trade diversification.

Aside from your comments about continuing to want to gravitate away from those tenants that have a customer base that are paycheck to paycheck, how does that diversification across the line of trades stack up relative to your sort of ideal target?

And what does that kind of, how does that compare with the opportunity set that you're seeing currently?

Yes, the opportunity set is wide, so there's a lot of things that come across the transom that we might have done a few years ago that we are not doing and moving away from casual dining would be one.

We still like convenience store, but that might be another.

So we could buy a lot more if we really didn't have this view in terms of where we want to take the portfolio.

One of the things that's happened that's been very fortunate is a few more of the investment-grade retailers are out in the market with opportunities, where they just weren't a few years ago.

Then also, we've widened the net so we can move outside of retail dealing with larger tenants.

So that's really given us the opportunity to do that.

I think if I could snap my fingers and make an instantaneous change in the portfolio, as one of the questions was earlier, why don't you go faster -- we would like to, but part of this is matching up opportunities and growing cash flow and dividends with what may be burn rate on selling a few things.

Right now there's plenty of opportunities out there, some of which weren't a few years ago, and we really do want to migrate the portfolio, particularly up the credit curve and away from casual dining.

I keep using that, but I use it because obviously half the consumers in the United States are more our middle- lower income, and that's where like we're currently seeing with the payroll tax and if $20 or $40 goes out of their paycheck, it goes out of their spending because there's not a buffer.

Thanks very much.

That's all I had.

Our next question comes from the line of Todd Lukasik.

Please go ahead.

A few more on the acquisitions.

On the $550 million expectation built in for 2013, does that include an expectation of any portfolio deals within that $550 million, or would they all be incremental to that?

No, I think it includes portfolio transactions.

But it's one of those where it looks like the first quarter's going to be pretty good and then you move on from there.

We're looking at some portfolio transactions, but you don't know how many come through.

As you know, in the past we started at $250 million and kind of guided up as the year went by.

But given the last three years of $1.1 billion, $1.7 billion, and the flow, we kind of sit here, look at each other, look at the first quarter, and say during the course of the year, we ought to get there.

But John mentioned 80% last year was larger transactions, so in this I'd say at least half is.

Yes.

You mentioned the increase in staff, and adding people to help deal with larger flow of acquisitions.

Is that where the majority of the increase in staff is going, and could you maybe compare the staff that's responsible for evaluating these deals today versus what it was say in 2009, before you embarked on the portfolio diversification strategy?

Yes, we probably added a couple people down there in that, and in acquisitions a couple people.

Then it just floats around the building, because a lot of this was systems and volume.

I think looking forward to this year that's where the differential will be.

I think we may have a pretty good add this year in acquisitions once again; and a pretty good add maybe five, six in the research area, be it real estate research, and then maybe an executive or two with specific expertise.

Then again, I think just looking at all the volume we added this year and moving towards capacity, you have to add ones and twos throughout the building by department.

I think this will be the year, and it may not be exactly calendar that that will flow in.

I'm really thinking specifically in research and specific segments with some people we can bring in that have done a lot of work there, and research and acquisitions primarily.

Okay, and then the $17 billion you mentioned in deals that came through your door last year, does that include ARCT?

Yes, that does include ARCT.

Okay, and then with regards to the industry exposures you were talking about.

I guess in recent history you were comfortable in some of those industries being up near about 20% of revenues.

Is there a new target that you kind of have in mind in terms of where you wouldn't want to go beyond now?

I know the C-stores are around 12%.

Could some industry concentrations go higher than that, or are you still looking to lower those across the board?

Well, we're kind of 20% is the farthest we would ever go, but we don't like 20% near as much as we did.

One of the things really watching going through the recession while we sailed through it is those exposures you did sit and worry about.

As we get to this size and in 44 different industries, it's just very fortunate that you can bring that down.

I now look at 10% as being on the high side, and it needs to be just because there's a particular opportunity that came along and it's something really light, but if we could keep them down around 5%, that's just a great, it would be a great event.

The exception, obviously, is if you end up working in an industry where you've got three or four really top-flight Fortune 500-type credits sitting in there.

But the answer is yes, the lower number is better.

Okay, and then last one for me.

I think you guys had announced that you'd do a dividend increase early this year regardless of whether ARCT closed.

I'm wondering what thoughts are going forward in terms of evaluating a fifth dividend increase throughout the year, and whether or not you expect that to continue to happen around the August time frame, or whether those will be more fluid discussions throughout the year?

Yes, it's -- with the pay-out ratio, if you look about where guidance is up around 91%, I'll tell you we're comfortable given the size of the portfolio and the added diversification you referenced.

We would like to walk that back down, but we've always been a mid-to-high-80%s-type Company, so it's not material on whether that happens over a year or two, we're open to.

So I'm going to first say it will be a more fluid decision.

I think the four increases are something we would plan on.

Then it's going to be really taking the pulse.

The reason we used August is usually by then we've put a fair amount on the books, and then we have some clarity relative to how the third and fourth quarter's going to look, and that gives us a little ability to see what the impact of that fifth dividend is, not so much in 2013 but 2014.

So we're really not going to be in a position to know until we get later in the year.

But given, obviously, we did the increase in August, which I think was $0.06 a share, and then we did the $0.35 -- we front-loaded a little bit of it, but I wouldn't want to take it off the table at this point.

Right.

Okay, thank you.

Our next question comes from the line of Rich Moore.

Tom, did you guys look at Cole at all -- the Cole that sold to -- in the portfolio that sold to Spirit?

We look at lots of stuff.

As you can imagine, given the size, get an opportunity to look, we think, at most everything comes across the line, and that would be a logical thing to do.

But on everything that comes in, John references the $17 billion, there's a tremendous amount we've signed confidentiality agreements on.

So it's our policy not to reference transactions that we didn't do, and so I wouldn't want to go beyond that.

But I'll tell you there's been a lot of activity in the space over the last year, and it would be surprising if there were things we didn't look at.

Okay, fair enough.

Do you think there are more of those kind of entities that will be coming along?

I mean is that -- are we done, or is it just Cole and ARCT, or there are more out there currently.

I'm just wondering if they will be making their way to market?

It's interesting.

A lot of that is generated by the private REIT space, where there's just a tremendous amount of money being raised through the financial advisor community for those type assets.

They traditionally, if you go back, had this longer life, which as of late's gotten shortened up, because the liquidity event is something that obviously is considered favorable by those people that put these in their clients' portfolio for a number of reasons, economics being some of them.

Secondarily, I think it also enhances the business model of the sponsor.

I would see more coming since there's a lot being raised.

If you look at the business, where traditionally it was a lot wider relative to the property types that we're dealing in a good part of the business is net lease today.

So I think there's more out there, and then I'd reference back to just a lot of the Opco/Propco-type stuff.

So it's hard to know what it will be, but I think there will be some larger transactions coming out there.

It's a good time to mention -- we've over the years on an M&A side, and you and I have talked about this -- have had a lot of opportunities and things presented that could have been done.

One of the real challenges is underwriting in one fell swoop a big portfolio like this.

You spend a lot of time underwriting on a very granular basis and this comes along and it really puts pressure on the underwriting side of it.

If you look at this particular transaction, it was one where it was mostly investment-grade, and it was a lot of the same tenants we work in, in areas that we had targeted.

That was one of the reasons we're able to do it.

It was also a fairly new portfolio, so the leases were long.

But with some of these, as they age and they come to market, then it brings up a lot of those issues that might make it a little more troublesome for us, but we do want to look at all of them.

Okay, good, thanks.

That kind of answers a little bit the next question I have, which is going back to the selling of assets.

I'm curious why you guys might not do a portfolio-type sale, given that I understand that there's cash flow implications.

But you're obviously buying a lot of things.

As a matter of fact, if you only bought $550 million worth of stuff this year you'd kind of wonder why you'd even have to clear the line of credit, so I kind of think you'll do more than that.

If you're doing more than that, why not a portfolio transaction if there's someone that can evaluate the portfolio and then get rid of the bottom 2% of your portfolio kind of thing?

Right.

Well, while they may be our stepchilds, we love our stepchilds.

Doing it in volume presents some issues for the ongoing cash flow stream and its consistency, which since we're the monthly dividend Company that's very important.

We did look at a couple of those ideas.

I referenced earlier a block of C-stores and we ended up pulling it off the market.

We may do a bit more of that.

As we're buying, like in ARCT and have been asked a couple times here -- you guys going to sell part of that?

We really, as you know, have taken the entire portfolio and do it again and stratify it.

We do have about I'd say 20% of the portfolio that we would like to move off over time; but some of those are also properties that have been on the books, so the leases are a little shorter.

Some of them have some other characteristics that make it a little more challenging in a bulk transaction.

Again, I think if people think towards the 100 and over number for this year, that's probably the right one.

Okay, very good.

Thank you very much.

This concludes our question-and-answer portion of the Realty Income conference call.

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

Great.

Well listen, thank you everybody for a little over an hour of time here.

We appreciate it in the busy earnings season, and we'll look forward to seeing you out at conferences and look forward to talking to you again next quarter.

Thanks Paul, thanks John, and thank you, Katya.

Ladies and gentlemen, this concludes our conference for today.

Thank you for your participation.

You may now disconnect.