Realty Income Corp (O) 2013 Q2 法說會逐字稿

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

Welcome to the Realty Income Second Quarter 2013 Earnings Conference Call.

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

Please go ahead, sir.

Great.

Thank you, Cherelle, and good afternoon everyone.

Welcome to the conference call and thank you for joining us.

In the room with me today I have Gary Malino, our President and Chief Operating Officer, Paul Meurer, our Executive Vice President, Chief Financial Officer, Mike Pfeiffer, our EVP General Counsel, and Sumit Roy, our Executive Vice President, Acquisitions.

And as always, 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.

And as is our custom, why don't we start with Paul to walk through the quarter.

Thanks, Tom.

As usual, I will 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 63% for the quarter.

Our current revenue on an annualized basis now is approximately $765 million, and of course this increase reflects positive same-store rents of 1.1% but more significantly, it obviously reflects our growth from new acquisitions over the past year.

On the expense side, depreciation and amortization expense increased significantly to $78 million in the quarter, as depreciation expense has obviously increased naturally with our portfolio growth.

Interest expense increased in the quarter to $39.1 million.

This increase was primarily due to the $800 million of bonds that were issued last October as well as some credit facility borrowings during the past quarter.

On a related note, our coverage ratios both remain strong with interest coverage of 4.1 times and fixed charge coverage at 3.3 times.

General and administrative, or G&A expenses in the second quarter were approximately $12 million.

Our G&A expense has naturally increased this past year as our acquisition activity has increased, and we added some new personnel to manage a larger portfolio.

Our employee base has grown from 89 employees a year ago to 104 employees at quarter-end.

However, our total G&A as a percentage of total revenues has decreased to only 6.5%.

And this compares to a historic run rate for G&A of about 7.5% to 8% of revenues.

Our current projection for G&A for all of 2013 is about $50 million.

Property expenses were just under $3.3 million for the quarter and our property expense estimate for all of 2013 remains about $15 million.

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

They were $722,000 for the quarter.

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

During the quarter, we spent $605,000 of such remaining costs.

Income from discontinued operations for the quarter totaled $3.9 million.

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

We sold 17 properties during the quarter for $23.7 million, with a gain on sales of $5.7 million and just a reminder that we do not include property sales gains in our FFO or in our AFFO.

Net income attributable to non-controlling interest refers to the limited partners of the operating partnership that we purchased in the ARCT acquisition and a new Realty Income LP we formed this past quarter.

The assets and operations of these two subsidiary partnerships are 100% consolidated into Realty Income.

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

Net income available to common stockholders was about $44.2 million for the quarter.

A reminder that our normalized FFO simply adds back the 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 published on us.

Normalized FFO per share was $0.61 for the quarter, a 24.5% increase versus a year ago.

Adjusted funds from operations, or AFFO, or the actual cash that we have available for distribution as dividends was $0.59 per share for the quarter, an 18% increase versus a year ago.

We again increased our cash monthly dividend this quarter.

We've increased the dividend 63 consecutive quarters and 72 times overall since we went public over 18.5 years ago.

Dividends paid per common share increased 24.5% this quarter versus the same quarterly period a year ago.

Our current monthly dividend now equates to a current annualized amount of approximately $2.179 per share.

Our AFFO dividend payout ratio year-to-date has been 87%.

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

Earlier this month as you know we raised $750 million of new capital with a 10-year bond offering at 4.65%.

Our $1 billion unsecured acquisition credit facility currently has zero borrowings, and this facility also has a $500 million accordion expansion feature.

We assumed approximately $65 million of in-place mortgages during the quarter as part of our property acquisition.

We now have 51 assumed mortgages on 229 properties totaling approximately $793 million.

Our upcoming mortgage maturities, though, are only $24 million the remainder of this year, and $64 million in 2014.

Our next bond maturity is only $150 million which is not due until November 2015.

Our overall current total debt to total market cap is 29.5% and our preferred stock outstanding is only 4.5% of our current capital structure.

So in summary, revenue growth this quarter was significant and our expenses remain moderate, though our earnings growth was very positive and our overall balance sheet remains very healthy and safe, and we continue to enjoy excellent access to the public capital markets to fund our continued growth.

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

Thank you, Paul.

Let me start just by saying I think in the second quarter we continued pretty good positive momentum from the first quarter and had I think excellent results in each facet of the business, and I'll start with the portfolio which again generated very consistent income during the quarter.

Pretty much across the board, the tenants are doing well.

No issues arose with any of the tenants during the quarter, and based on what we see now that should be the case during the third quarter.

Very, very smooth.

At the end of the quarter, our largest 15 tenants, and they're listed in the release, accounted for 43.5% of our revenue.

That's down 500 basis points from the same period a year ago, and up 90 from the first quarter.

There may be some, I think, ebb and flow from quarter to quarter in that, but our acquisition efforts continue to help us reduce concentrations pretty much throughout the portfolio.

And we've made continuous progress in that over time.

If you look back say five years ago to 2008, our top 15 tenants accounted for 54.3% of our business, of our revenue, and today that's 43.5%.

Relative to occupancy, we ended the quarter at 98.2% with 68 properties available for lease out of the 3,681 we own.

That occupancy is up 50 basis points from the first quarter and up 90 basis points from the same quarter a year ago, and really is a function of very good progress on leasing during the quarter.

And I would say looking forward here in the third quarter, we think occupancy should remain at this level or perhaps up a bit more, and overall occupancy is very strong.

We've reported occupancy this way for a very long time, which is taking vacant buildings against those that are occupied to figure those numbers.

There's another way to do it.

We could do it by vacant square footage and divide it by total square footage.

That would give you occupancy of 90%, or the third way is to take previous rent on vacant properties and divide that by the sum of that number and the rent on occupied properties.

And if you use that methodology, vacancy is only 0.9% and occupancy 99.1%.

So, each obviously of the three methodologies indicates very good occupancy.

Same-store rents on the portfolio increased 1.1% during the second quarter and 1.3% year-to-date.

As you recall during last year, same-store rent was just modestly positive for the year so getting back up to a run rate of 1% plus is pretty good and I think a good rate for the portfolio, and we think that will continue over the next few quarters.

Diversification of the portfolio continues to widen.

We're up to 3,681 properties, with 194 tenants.

They're in 46 industries and 49 states around the country.

I think industry exposures are well-diversified, given we have 46 industries and the concentrations on the major ones continue to come down a bit.

And this has been going on really for the last few years.

Our largest industry right now is convenience stores.

That's at 11.4%.

That's down 60 basis points from last quarter and 550 basis points from a year ago.

That was once close to 20% of the portfolio, and so getting it down and inside 10% is something we want to do.

Restaurants, if you were to combine both categories, casual dining and quick service, we now have down to 9.9% or below 10%.

That's down 60 basis points from last quarter and 390 basis points from a year ago, and of note that was once 22% of revenue.

We then jump to drug stores at 6.9%, theatres at 6.3%, and health and fitness and transportation at 5.9% and then dollar stores at 5.6%, and all of the other industry categories that we have are under 4%.

So, I think pretty good shape and keeping an eye on concentrations by industry.

I think that's true also from a tenant standpoint.

Our top three tenants, number one is FedEx at 4.3%, that's down 40 basis points from last quarter.

LA Fitness is at 4.5%.

Walgreens, which we've been adding to the portfolio, is at 4.1%.

That's up about 120 basis points, and every other tenant we have is below 3.5%.

And when you get to the 15th largest tenant, which is Wal*Mart-Sam's Club, you're looking really only at about 1.7% of revenue, and it goes down from there.

So certainly, well-diversified from a tenant and we also think geographic standpoint.

Average remaining lease term remains very positive at 11 years, and overall we're really pleased with the portfolio and it's generating very consistent income with very high occupancy.

Relative to portfolio dispositions, we continued to sell some properties out of the portfolio during the quarter.

The goal, obviously, is further strengthening the credit quality of the portfolio and doing that by reducing exposures to industry and tenants, and properties where we think they might be particularly sensitive to reduce economic activity or a slowdown in the economy.

We're also, maybe with tenants whose balance sheets are significantly levered and might be impacted by higher interest rates, and that has been a theme for us for a while.

Paul mentioned during the quarter we sold 17 properties for $23 million.

For the year, it's 34 properties with $83 million.

For those that are on the call on a regular basis, you'll recall that our goal was over $100 million and perhaps up to $125 million, and sales will ebb and flow on a quarter-by-quarter basis but $100 million plus is definitely where we're heading and we're most of the way there now.

And we may up that estimate in the coming quarters and do some additional dispositions above and beyond that.

And once again, the sales primarily during the quarter were in the restaurant industry which we continue to reduce, and the child daycare industry, and both are targeted.

We'd like to sell off some properties in those areas.

I think overall, we're very pleased with the operations of the portfolio and have made good progress.

Let me move over to property acquisitions for a moment.

As I've said, virtually every quarter forever, but it's a good reminder, acquisitions can be quite lumpy quarter-to-quarter and year-over-year.

And a challenge to predict certainly by the quarter, and that continues to be the case.

In the second quarter we were very active on the acquisitions front and pleased with a really high level of activity and acquisitions.

We acquired $738 million in properties invested in 190 different properties, and that is the most acquisitive quarter for property level acquisition in the company's history.

Average cash-on-cash cap rates were at 6.8%.

Kept nice long lease terms in the acquisitions at 14 years, and also 70% of the properties acquired during the quarter were leased to investment-grade tenants.

As most of you know, that has been one of our focuses.

Also, good diversity, they released 19 different tenants in 16 industries with the most significant industries represented were in drug stores, wholesale clubs, and in convenience stores, and well-diversified geographically in 32 states.

And 90% of the acquisitions during the quarter were in our traditional retail properties.

That gets us for the first six months of the year, then, to $867 million that we invested in 206 properties.

Cap rates there 7%, and long-term leases again at 14 years and about 61% of the acquisitions leased to investment-grade tenant.

That's obviously well above, at $867 million, our initial full-year 2013 guidance of $550 million.

A couple of weeks ago we bumped that guidance up in excess of $1 billion.

And given really some transactions that have come to fruition in the last few days, yesterday in the release we changed that to $1.25 billion, and very, very pleased with that process.

But we think you know, a good share of them as we get now later in the year we'll close toward the end of the third and fourth quarter.

That's fairly typical and so, the impact to 2013 numbers may be modest depending on when the closings actually happen, but obviously very accretive to the 2014 numbers.

And that $1.25 billion will be in addition to the $3.2 billion acquisition of [RT] that we did in the first quarter.

Looking at transaction flow, I talked about it being very, very robust last quarter, and it's really been a record amount of flow that has come into the market substantially.

During the first six months of the year, we've sourced about $20 billion in acquisition opportunities that have come through the door and $15 billion of that alone came in the door during the second quarter.

To put that in perspective, that's more insourced acquisition opportunities year-to-date than we've ever seen in a full calendar year.

Last year was a very heavy year for acquisition opportunities at $17 billion.

The year before was $13 billion and previous to that it had never really exceeded much over $5 billion, so the $15 billion during the quarter and $20 billion year-to-date represents really just a stunning level of opportunities that were out there in the marketplace with people bringing properties out for sale.

A number of those, as some people have probably noticed, were large portfolio and entity-level acquisition opportunities, but also there were a lot of very small kind of granular individual property opportunities that came to market during the quarter, so it remained very active.

I think we've remained very selective in the acquisitions and have been trying to pursue only those things that match where we're trying to take the portfolio strategically.

And we continue to look at a few of the acquisition opportunities that came in in the second quarter but have elected not to pursue the vast majority of them.

I think a number of the transactions for us had issues relative to the industries the tenants were in, and who their consumers are.

Also with pricing and structure.

And I think it's generally been the case that in a large portfolio, unless the overwhelming vast majority of the properties fit the investment strategy, we'll likely elect to pass on them and not pursue growth just for growth's purposes.

But overall, obviously very pleased with acquisition volume and also very pleased that in past years, and we had some decent sized acquisitions go through this quarter, that just as I said a moment ago, a lot of the acquisitions have been property, property by property, and smaller organic level transactions, and really allowed us to make some good progress with the portfolio.

Let me talk to pricing and cap rates, which I think is really interesting.

Cap rates have ticked up a bit over the last six weeks or so, as we saw movement in rates in the capital markets.

Cap rates started moving it at the same time and probably seen about a 25 basis point move-up in cap rates overall just in the last six weeks or so.

And historically, that does not usually happen this fast, and usually it takes longer for cap rates to adjust to movements in the capital markets.

And sometimes, they may even lag by six to 12 months.

And in the recent kind of moving in the capital markets, things seem a bit different this time.

And put some thought to it, and I think the reason that they, cap rates started moving quicker this time, is that more and more of the acquirers in the net lease business now are institutional buyers such as ourselves.

Certainly than was the case in the past, and I think our business historically has been dominated by a very large group of one-off transactions, primarily driven by individual investors that had a big impact on the pricing in the market.

And that's flip-flopped a bit, as more institutional buyers have emerged and it's a smaller group, albeit of large players that seem to be impact to pricing.

So, really a movement in the cap rate stance by a few larger buyers, I think likely can adjust cap rates a bit faster than what we've traditionally seen in the net lease market for a very long time, and I think that's been the case here.

In the market right now, investment-grade properties, properties leased to investment-grade tenants, cap rates have moved kind of in the 6.25% up to 7.25%, certainly up 25 basis points, maybe a few basis points more.

And I think the same thing with non-investment-grade cap rates which are in the 7.25% to 8.25% range, also up 25 basis points.

And again, that's just really over the last five, six weeks or so.

And normally I'd wonder about that and wonder if it's anecdotal, but given the flow and the volume of activity that we see and that we're working on, I think it's pretty representative of what's going out, happening in the market.

So, caps moving up with capital costs as quickly is unusual, but obviously we're pleased by that.

Looking at spreads, our investment spreads remained very healthy in the second quarter.

As I mentioned a minute ago, we invested $866.5 million at a 7% cap rate.

We financed basically almost all of that recently with the 10-year unsecured bond offering that Paul talked about with a [4.65%] coupon, so a spread of a little over 230 basis points, which is excellent.

And that's pretty much everything that we've done year to date.

And as we've frequently discussed when we talk about spreads, historically we've looked at our spreads first relative to a nominal cost of equity, which is taking a forward FFO yield, dividing it by the price of the stock and then grossing it up for issuance cost.

And if you look back over the last 20 years, that spread over a nominal cost of equity has averaged about 112 basis points, and I mention that during the last 20 years the vast majority of the time we were acquiring properties leased to less than investment-grade tenants.

And if you look today, with well over half the acquisitions, a little over 60% going to investment-grade tenants, cap rates for the first six months were at 7% and that nets you about 130 basis point spread to the nominal cost of capital if you calculate it at where we are today.

And that's a good 20 basis points over the 20-year historical average, so in a little bit, but still quite healthy.

And then relative to what we did in the quarters, obviously spreads are higher using debt issuance.

So, I think we still like the spreads relative to what we've achieved historically out there.

When most of our acquisitions were less than investment-grade and today the majority are investment-grade, and obviously on the spread front, cap rates ticking up a bit is helpful.

Relative to the volume and what we're looking at going forward, we feel it is still a very robust market with a lot of product to look at.

We'd be very surprised to see the volume of opportunities in the third and fourth quarters that we saw in the second quarter.

The $15 billion again was pretty exceptional.

But going forward, there's still very active flow, and we expect our activity to remain pretty robust the remainder of the year.

But likely as always continue to be lumpy, but we're very optimistic we'll have a banner year.

You noticed in the release we moved the estimate, as I mentioned, to $1.25 billion.

We're highly confident on that, and then we'll see if we can make some additional progress for the remainder of the year.

Very positive on acquisitions.

Let me just get back to the portfolio for a second.

And all this acquisition activity obviously has had a big impact on the financials, revenue earnings and dividend, which is apparent in the numbers here.

But it's also had a material impact on the makeup of our portfolio and where we're trying to move it up the credit curve, and we continue to make good progress on that.

The percentage of our revenue during the quarter that is generated by investment-grade tenants was up to 38.2% for the quarter.

That's up 240 basis points over the first quarter, and I just update a few numbers here that I went through in the first quarter.

I think it's helpful to do.

Over the last 36 months or so, we've acquired about $6.6 billion in property.

About $4.5 billion of that is in retail, which is traditional for us in sectors that we think will continue to perform well if we get a tough retail environment, goes on.

And then $2.1 billion we've acquired in areas outside of retail, almost all investment-grade that we think will do well for us.

Out of that $6.6 billion, $4.1 billion or 62% has been with investment-grade tenants, and a good part I think of the balance of the acquisitions while non-investment-grade certainly are further up the credit curve than we had average in the portfolio, just a few years ago.

Some other interesting numbers, and I'll track this back over the last five years from 2008.

As I mentioned earlier, in 2008 the top 15 tenants did 54.3% of our business.

If you looked at their average [dar] score, and as a lot of you know that's the credit score internally we use that approximates a credit score similar to what the rating agencies do, the dar score on average for the top 15 tenants was a 6.92, which equates to about a BB-minus credit rating and in 2008, none of the top 15 tenants had investment-grade ratings.

Today, the top 15 do 43.5% of the revenue.

That average dar score is now 11.78, which approximates to about a really BBB but closer to a BBB-plus credit rating.

It's up substantially, and 8 of the top 15 tenants now carry investment-grade ratings.

So if you look at really in the last, for the top 15, four-and-a-half years, percentage of revenue from 54% to 43%, the dar score from 6.92 to 11.78, and then from 0 to 8 at the top 15 tenants with investment-grade ratings.

And so, pretty pleased with those trends.

At a couple of the industry meetings lately, and I've alluded to this on the call, there's another way to look at the adjustments.

I'll spend a minute on, and if you go back two years ago from right now in July of 2011, we went back and re-underwrote our largest tenants.

We did that for 67 tenants that produced 83% of our revenue, and really did that using 19 different metrics to try and assess the risks that they might represent to our revenue stream in a rising interest rate environment or a weak economy.

It included rankings on each industry, based on that industry and how it operates its margins, and the consumer that really they serve an analysis of concentrations, balance sheet and income statement analysis, and then a pretty heavy sensitivity analysis where we stress tested them moving their revenue and their margins, and then their sensitivity to interest rates on refinance on their balance sheets.

And based on that, if you took the portfolio, at least the 67 tenants that did 83% of our revenues, we broke them up into four categories and I'll do them one as green, which is strong buy, one is yellow, which is buy, red which is hold, and black which is sell.

And back in 2011, tenants representing about 22.8% of our revenue were in the green strong buy category, 21.4% in the yellow or buy category, about 15.9% in that red or hold category, and then 22.9% in the black or sell.

And again, they represented about 83% of our revenue.

Pretty much two years here exactly, we just recently updated that and given the pretty robust acquisition and disposition activity, we now do that each quarter and it represents 121 tenants that do 88.1% of our revenue.

But if you look at the breakdown today the green or strong buy category, tenants in that category have moved from 22.8% of our revenue in 2011 to today over 45.1%.

In the yellow and buy, it's gone from 21.4% to down a bit, 18.4%.

In the red from 15.9% to 15.8%, but most importantly in the black, or sell, category, which was 22.9% of our revenue in 2011, it is now 8.8% of the revenue.

So, substantial and I think material progress in moving the portfolio to some degree with dispositions, obviously to a lesser extent, but certainly with all the acquisitions we've done it's had a pretty material impact.

Let's move to the capital side for a minute.

And I mentioned that we've bought about $6.6 billion over the last three years.

I think how that's been capitalized is important.

I'll run through the numbers.

We've issued about $1.8 billion of long-term notes or bonds at very good rates.

We've assumed on some larger transactions about $793 million in mortgage debt.

We also generated about $178 million from property sales, and then $409 million in perpetual preferred offerings.

But, most importantly, in the last three years we've issued equity six times during the period, equivalent to about $3.7 billion.

So, that's about $6.8 billion in capital total.

Over $4 billion of it was common and preferred, and of the remaining none of the capital is variable rate, most all of it long-term, and I think that puts us in pretty good shape relative to if we see a further rising interest rate environment.

And as those of you who are on the calls know, preparing for a rising rate has been a theme for us on the calls in the last few years relative to capital issuance and trying to grow up the curve.

And I think we've been able to do this while moving the needle pretty well on FFO and dividends.

Let me finish off with just a few relative to access to capital now.

As Paul mentioned, we're in good shape.

Plenty of dry powder, no balance on the line, and even with the 10-year moving up we have access to capital at good rates, and more importantly, good spreads on the acquisitions.

Earnings for the quarter, as Paul mentioned, were very strong so let me just move on to guidance.

We made the adjustment a couple weeks ago to $1 billion, and as I've said a couple times, up to $1.25 billion.

However, on earnings guidance we did not change that.

I mean, we did a couple of weeks ago and that is now 237 to 243 on normalized FFO, and that's 17% to 20% growth.

And on AFFO, 235 to 241, or 14% to 17% growth.

And even though we think acquisitions will now be larger than expect as we left the guidance where we took it a couple weeks ago.

I noticed in some of the research notes this morning, there were some question on that, so let me -- let me take a moment and kind of go through the thoughts, there.

We just upped the guidance a couple of weeks ago by a nickel on both FFO/AFFO, and it was really just some transactions coming together in the last couple of days that really made us confident to move the acquisitions guidance to $1.25 billion.

And that again causes us to be very confident on current guidance, but I think there's some variables or levers in the business I'd like to maintain some optionality on for now, rather than moving guidance up further.

One is the timing of the closings and how that's going to impact numbers.

Obviously, sooner creates a little more FFO on the '13 numbers than later, and as we get here later in the years, the acquisitions have less impact.

And then next, trying to discern what if any volume there's going to be above and beyond that.

And I think that will play itself out over the next couple of months or so.

Next is you know, what are permanent capital costs?

Given the volatility lately we like to hedge that a bit, and so we've done that.

And then I think also one of the levers we'd like to keep is whether or not we expand the disposition level a bit over the $100 million to $125 million level, and we may do that.

And then finally, I think it comes down to trying to assess what type of capital we would use next.

Do we use equity or something else?

And those would have different impacts on the numbers, given share count.

And then really, it's just trying to maintain some optionality primarily on capital and disposition, so we will revisit it down the road.

We don't want to get too far ahead on the numbers, at least for right now, but obviously the growth numbers and the guidance having recently upped it, are very positive.

Finally, I'll end with our -- for our shareholders whose primary focus is dividends, which as you know is a great deal of them.

Paul mentioned dividends paid were up 24.5% quarter-over-quarter.

We've increased it three times this year, and we remain optimistic that our activities will support continued increases in the dividend.

I want to thank you for your patience.

It was an active quarter, and Cherelle if you'll come back, we'll now open it up for questions.

(Operator Instructions) Our first question comes from the line of Juan Sanabria, with Bank of America Merrill Lynch.

Please go ahead.

Hi, good afternoon.

I just had a quick question with regards to your capacity from a balance sheet perspective.

How much could you debt fund before you'd be a bit uncomfortable with your leverage ratio?

And I guess a second question, while I've got the floor, is just what are your views on acquiring assets with lease terms below 10 years?

What sort of cap rate spread would you have to see relative to your traditional focal point?

Well, from an overall leverage standpoint Juan, we historically have run kind of in the -- I'll give a broad range for a second, 20% to 35% leverage range, 5% to 15% preferred.

When I refer to 35% debt, and 15% preferred, I'm referring to maximums that we're comfortable with relative to that.

So today, debts around 30%, preferreds around 5%.

We obviously do have capacity in both buckets, and certainly stay in concert with issuing equity as well.

You know, we would continue to have capacity in those buckets, but we view maximum levels as kind of 35% debt and 15% preferred.

And actually prefer that they be more in the 25% debt level, and in the 5% to 10% preferred level.

So, you know, we have an old phrase we use internally which is go equity first, so to the extent that common equity is well-priced and accretive, that's something we would always keep our eye on as something we'd be more likely to take a look at before we looked at the fixed income side.

On the second question, Juan, relative to shorter leases, it has been very, very, very rare for us to go much inside 10 years.

The only time I can remember is when we bought a large portfolio and just a couple, three, four, five of the properties would be inside of that.

We're really trying to go longer up in the 14, 15, 16, 18, 20 to keep the lease duration on the portfolio long and allow the revenue to be very stable.

When you're in the net lease market and you're out there selling properties, if your lease length is 10 years or longer generally the cap rate it will command will be much, much better than when it moves inside 10 years.

And as you get shorter down into 6, 5, 4, cap rates rise pretty dramatically.

That's generally a function of release risk that is hard to tell on a lot of net lease assets.

And when you're out buying shorter term leases, generally those aren't generated in a direct transaction.

With a retailer or a large corporate tenant, generally you're buying those out from another owner in the open market, and if you didn't underwrite them yourselves you may not have cash flow coverages or the profitability of the individual stores that you're buying.

And that makes it difficult to assess the risk of whether the tenant will re-lease, certainly in the case of retail.

And you'd want to make sure you had that, and if you didn't have it, then the cap rate's going to rise because of the uncertainty relative to rollover.

So, you'd really have to be assessing what you paid per square foot, and what the rent is per square foot, and what you think market would be.

But generally those command much higher cap rates, and it's very rare.

Our strong, strong prejudice is not to go into that game.

We've looked at that business maybe 15 times over the last 20 years, but really found it difficult to underwrite.

So generally, we're looking up in the 12, 13, 15 to 20-year lease when we're acquiring properties.

Thank you very much.

Thank you.

Our next question comes from the line of RJ Milligan with Raymond James and Associates, please go ahead.

Hey guys, good afternoon, good evening.

Hey, RJ.

I'm just curious, Tom.

The volume, the $15 billion in the second quarter, is that -- was that a reaction to the 10-year moving, or was there something else driving that surge in volume?

Yes, no that was really pre- the taper tantrum, as somebody said it the other day, and the movement in the 10-year because most of that that hit the market came in middle, earlier in the quarter, and also came of course, was structured before that and the decision to bring it to the market generally is a few months before that.

And it's a couple things going on.

One is, is just there's been a growing knowledge of net lease, sale leaseback, and I think that's a function of a lot of the talk in the fourth quarter and the first quarter with bankers out calling on really Fortune 500, and every tenant they have or every company they have about using their real estate, take it off balance sheet.

So, just a wider knowledge of using sale leaseback as part of the capital structure by corporations.

I think also there's just been a lot of potential M&A transactions, a number of those have been noted in the press, and those came to market and I think it was also representative the companies are figuring out that rates are pretty good and it might be a good time to do it if you're going to, coupled with some of the private REITs or fund business that is really you know, at the part of the cycle where they need to come to market.

And the confluence of all of those at one time led to a lot coming on the market very quickly.

A lot of that will get done, got done.

Some of it won't, and then when the 10-year moved you saw the -- you saw cap rates move a bit.

But, it was just a heavy quarter, and it was all of those things coming together.

I don't think we're going to see that this quarter, or next quarter, but the volume still remains very elevated over where it was a couple of years ago.

So it's slowed since the middle of May, or?

Yes, I mean, $15 billion is a ridiculous number.

But if you go back again two or three years ago, us seeing $5 billion a year was the number and it's certainly running way the heck ahead of that.

It's still very strong.

You know, we saw $5 billion in the first quarter and Sumit, you want to hazard a guess of what you think we'll see in the third and fourth?

(technical difficulty) the $5 billion for the remainder of the year.

Yes, okay.

Okay, thanks.

Thank you.

Our next question comes from the line of Jonathan Pong with Robert W. Baird, please go ahead.

Hey, good afternoon, guys.

Hey, Jonathan.

What are your thoughts as you look at the potential large portfolio deals, either on the publicly-traded side or the non-traded side, that might need a liquidity event over the next year or so?

What would you say is your appetite right now for those kinds of deals, and all else equal in terms of tenant quality, lease duration, what would you say is the yield spread you need to see between a portfolio deal and one-off deals that would make you more [constructive] in pursuing those?

Yes, it's really interest -- that's an interesting question.

Let me come at it a few ways.

I said on last quarter's call something very strange in the business right now is, because of the additional institutional buyers, traditionally if you had a large portfolio transaction the cap rate on that would be higher than a one-off, really rewarding the person for putting out a lot of capital in one fell swoop.

And starting about a year ago, that all reversed as you had a number of institutional buyers who were trying to put capital out and had raised funds, and had difficulty putting it out.

And a one-off transaction would move the needle for them.

So anytime anything came in at $75 million, $100 million, $200 million, $300 million, all of a sudden there were a lot of people looking at it and so cap rates really inverted, where those were only trading inside a one-off of the same tenant.

So that's unusual as long as I've been in the business, but I think still where we are.

And so, if I -- I said earlier that you know, investment-grade cap rates are at the 6.25% and 7.25% rate, I think a large transaction would fit in mid in that, and same thing in a less-than-investment-grade.

And relative to us looking at them, we'd love to do it.

We're more than happy to do it, but one of the terms brought up here recently is, given all the volume that came to market the odds were good but the goods were also odd.

So, when you start looking at the quality of portfolio, we're trying to move more investment-grade and there was a number of the things that came to market that were not.

And some that then had a make-up in the portfolio that didn't fit some other characteristics, rather than the industries we want to be in.

And so, we're really going to kind of limit what we do on those unless the vast majority of the properties, as I said earlier, kind of fit.

But with that said, we're open to it.

There's some floating out there and we'll have to watch where they are.

I guess as you guys look further out into that pipeline, that M&A pipeline, are you thinking of deals that might come to market that you're sort of holding off for?

Or are you sort of taking a more short-term view?

Yes, no, I mean we're just taking them as we come.

As I said, we're really happy.

Sumit Roy who's running acquisitions and John Case, our Chief Investment Officer, kind of took our acquisition group and split them up into different areas earlier in the year.

And we're very happy with kind of the granular one-offs that we're able to bring in much more than in the past.

That's really lessened the reliance, I think, for us on larger transactions, but we're pretty happy with the volumes coming in so we don't feel compelled to go out and grab them.

But we're more trying to watch what's really steaming up out there, and what would fit, and then when those come, wanting to make sure that we pursue them fairly aggressively.

And on the other ones, not a high level of interest if it doesn't fit where we're trying to take the portfolio.

That's helpful.

Thanks a lot.

Thank you.

Our next question comes from the line of Todd Stender with Wells Fargo.

Please go ahead.

Hi.

Tom, with the big number in Q2, the $15 billion that came in, is that absolutely everything that's being marketed or is that just been screened through you guys and then from there you break it down to see if it fits your long-term lease profile?

Yes, I am sure that there were things that we didn't see, particularly smaller, but those are all of the things that came in the door that would reasonably be assumed that they would fit into categories that we would buy.

And then we started screening, and from there what happens is the acquisition group -- and they all have financial backgrounds -- do the initial screening, understanding our objectives, and they can start throwing things out pretty quick with just a day or two looking at them, and trying to be more selective with what we then really spend.

It goes over to research, the financial analysis is done, and we get deep into it, and then it goes to the investment committee from there.

So that is the all-in kind of number of everything we see that is you know, net lease, that Realty Income would look at the category, look at the type of tenant that comes in the door.

And is it reasonable to assume that that could be a long runway for you guys?

It's stuff you're looking at in Q2, could still be closing in Q4, and Q1 of next year?

Should this really provide a pretty visible runway for acquisitions?

Sumit, why don't you take that?

Sure.

Most of the $15 billion that we referenced, we've decided to pass on.

Some of them we've already found out who the eventual buyer is, some of it is still going through the process and I'm sure the eventual buyer will emerge over the next couple of quarters.

But none of those $15 billion that we referenced are portfolios that we've decided to pursue outside of the ones that we've either pursued or is in the pipeline to close.

And that's a very, very small percentage, less than 5%.

Yes, and the comfort level for the $1.25 billion is really taking those and the ones that we've pursued and we are going to get, and kind of looking at the timing of closing.

And that's how we kind of jump from the $866 million to the $1.25 billion, and there's a few exceptions but then you really want to start thinking that anything additional will come from what we're looking at right now, not what we looked at last quarter.

Yes, that's helpful.

And then Tom, you referenced a cap rate movement up about 25 basis points in the last six weeks.

Is it fair to say that that was more on below investment-grade, and that investment-grade cap rate is a little more sticky?

No.

Actually, we believe they both moved.

We've seen a lot of volume in it, and that was a major point of our discussion a few days ago, sitting there just parsing everything coming in the door.

So, we've seen it across the board.

Okay, and then Paul, you did pretty good color on how you're viewing the preferreds, and it sounds like the preferreds at the bottom half of your range of what you'd expect, maybe 5% to 10%.

Can you just kind of go into what the current market pricing is for preferreds, and kind of your philosophy if convertible preferred would be considered?

As you know, the preferred pricing widened over the last 45 days or so with the movement in interest rates.

Maybe even more so than bonds, it kind of made a big jump and it's taken a while for that to settle down.

Current pricing for us would be in the 6.5% range, call it, from a coupon perspective.

We suspect that'll continue to tighten as things settle a bit in that preferred market, and there's some demand on the horizon in that market.

But not at a level that makes sense, for example, to issue and take out our existing preferred, or that sort of thing.

But it is a bucket that we have capacity for and is reasonably priced and of course has a great maturity date, if you will.

So, if it matches up well in our balance sheet for long term assets, and matching with long term liabilities.

Convertible preferred is something we're open minded about.

I think it would need to be done in concert with a larger strategic entity level type situation where an equity element would be something to be considered, but as a normal ongoing [corporal] finance product in the balance sheet, it's not really how we choose to match fund our assets.

And not how we choose to manage the equity side of the balance sheet.

But it's something we listen to, we're open-minded about, and are knowledgeable about and would never say never, but it's not something we look to in the near term or as a regular course of financing.

Okay, thank you.

Thank you.

This concludes the Q&A portion of Realty Income's Conference Call.

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

Great.

Well, again, thank you everybody for your patience.

It was a very active quarter and we really appreciate you taking the time to visit with us.

Cherelle, I want to thank you for your help there, and this will conclude my part of the call.

Ladies and gentlemen, this concludes the Realty Income Second Quarter 2013 Earnings Conference Call.

If you would like to listen to a replay of today's conference, please dial (303) 590-3030, or 1-800-406-7325, with the access code 4628874.

We thank you for your participation and at this time you may now disconnect.