Realty Income Corp (O) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen.

Thank you for standing by.

Welcome to the Realty Income fourth-quarter 2013 operating results conference call.

(Operator Instructions).

I would now like to turn the conference over to Ms. Tere Miller, Vice President of Investor Relations.

Please go ahead, ma'am.

Thank you, Danielle, and thank you all for joining us today for Realty Income's fourth-quarter and 2013 operating results conference call.

Discussing our results will be John Case, our Chief Executive Officer; Paul Meurer, Executive Vice President, Chief Financial Officer, and Treasurer; and Sumit Roy, Executive Vice President and Chief Investment Officer.

Also joining us on the call is Mike Pfeiffer, our Executive Vice President and General Counsel.

During the 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 any forward-looking statement.

We will disclose in greater detail the factors that may cause such differences in the Company's 2013 Form 10-K.

Thank you.

I will now turn the call over to Mr. Case.

Thanks, Tere.

Good afternoon, everyone, and welcome to our call.

We're certainly pleased with our operating performance for the fourth quarter and our record-setting results for the year.

I am going to have Paul start and provide an overview of the numbers.

So, Paul?

Thanks, John.

Today, as usual, I will comment on our financial statement; provide some highlights of the financial results for both the quarter and the year, starting with the income statement.

Total revenue increased over 62% for the quarter and over 61% for the year.

This increase obviously reflects our significant growth from new acquisitions over the past year, as well as healthy same-store rental growth.

Our rental revenue at December 31 on a annualized basis was approximately $819 million.

You will note this quarter that we have also added new disclosure regarding tenant reimbursement as an additional revenue line item, as well as an identical offsetting amount added to our property expense line.

This refers to property expenses that we simply pay first and then get reimbursed by the tenant.

There is no financial impact to our earnings; they offset each other as revenues and expenses.

And this is simply new disclosure in our income statement this quarter.

On the expense side, depreciation and amortization expense increased to over $85 million in the quarter as depreciation expenses obviously increased with our portfolio growth.

Interest expense increased in the quarter to $50.6 million.

This increase was primarily due to the $750 million issuance of 10-year bonds last July, 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 3.0 times.

General and administrative, or G&A, expenses in the fourth quarter were approximately $16.5 million.

They were $56.8 million for the year.

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

Our employee base has grown from 97 employees a year ago to 116 employees today.

Overall, our total G&A in 2013 as a percentage of total rental and other revenues was still only 7.5%, or the low end of our historic run rate of 7.5% to 8% of revenues.

However, our 2013 G&A also had about $8 million of nonrecurring unique expenses from accelerated stock vesting of our old tenure grants back in the third quarter and the acceleration of our former CEO's pay compensation into the 2013 calendar year.

So our current projection for G&A for 2014 is only about $50 million, or approximately 5.5% of revenues.

Property expenses are noted as $13 million for the quarter and $39 million for the year.

However, as I mentioned, these amounts include property expenses reimbursed by tenants.

The property expenses that we are responsible for were approximately $3.7 million for the quarter and $13.9 million for the year.

And our projection for 2014 for property expenses that we will be responsible for is $16.5 million.

Income taxes simply consist of income taxes paid to various states by the Company, and they were $670,000 for the quarter and $2.7 million for the year.

Merger-related costs -- just a reminder: this line item refers to the costs associated with the ARCT acquisition earlier in the year.

And during the quarter we expensed the remaining $138,000 of such costs.

Income from discontinued operations for the quarter totaled $15.2 million.

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

We sold 22 properties during the quarter for $28 million, with a gain on sales of $14.3 million.

And 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 net income available to common stockholders was about $53.9 million for the quarter.

A reminder that our normalized FFO simply adds back the ARCT merger-related costs to FFO.

So our normalized funds from operations, or FFO per share, was $0.61 for the quarter, an 8.9% increase versus a year ago and $2.41 for the year, a 19.3% increase over 2012.

Adjusted funds from operations, or AFFO, where the actual cash we have available for distribution is dividends, was $0.62 per share for the quarter, a 12.7% increase versus a year ago; or $2.41 for the year, a 17% increase over 2012.

With this growth in earnings we again increased our cash monthly dividend this quarter.

We have increased the dividend 65 consecutive quarters, which is over 16 years of consecutive quarterly dividend increases.

Dividends paid per common share increased over 21% this year, and our monthly dividend now equates to a current annualized amount of $2.186 per share.

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

As you know, in October we raised $397 million of new capital with a common equity offering.

Also in October we expanded our acquisition credit facility to $1.5 billion.

As of today, we have $583 million of borrowings on that line.

We did not assume any in-place mortgages during the fourth quarter.

We did pay off some at maturity, so our outstanding net mortgage debt at year end decreased to approximately $755 million.

Our bonds, which are all unsecured and fixed-rate and continue to be rated Baa1, BBB+, have a weighted average maturity of almost 8 years.

Our overall debt maturity schedule is also in very good shape, with only $50 million of mortgages coming due in 2014 and $125 million of mortgages coming due in 2015.

And our next bond maturity is only $150 million, due in November of 2015.

Our overall current debt to total market cap is 33%, and our preferred stock outstanding is only 5% of our capital structure.

And our debt to EBITDA is only 6.1 times.

So in summary, revenue growth this quarter was very significant.

Our expenses remain moderate, so our earnings growth was very positive.

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 with well-priced, long-term capital.

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

Thanks, Paul.

Let me begin with the overview of the portfolio, which continues to generate consistent cash flow.

Our tenants are doing well, based on what we're seeing today.

As you see, we ended the year with 98.2% occupancy based on the number of properties, with just 70 properties available for lease out of our 3,896 properties.

This occupancy is up from 97.2% one year ago.

Our occupancy based on square footage and our economic occupancy are both at 99%.

Our property management group, the largest department in the Company, has done a great job managing this occupancy and handling our 1,600 lease rollovers since the mid-1990s.

We're expecting our occupancy to remain fairly stable for the foreseeable future.

Our portfolio remains diversified by tenant, industry, geography, and property type.

At the end of 2013 our properties were leased at 205 commercial tenants in 47 different industries and located in 49 states plus Puerto Rico.

77% of our rental revenue comes from our traditional retail properties, while 23% comes from non-retail properties, with the largest component being industrial and distribution.

We believe this diversification is important and leads to more predictable cash flow streams for our shareholders over time.

At the end of the fourth quarter our 15 largest tenants accounted for 44.6% of rental revenue.

That is down from 47.1% for the same period one year ago.

So we have continued to make progress on this over time.

In 2008, the top 15 accounted for 54.3% of our rental revenues.

Within the top 15 there was very little movement from last quarter to this quarter, with the same tenants being represented.

No single tenant accounts for more than 5.2% of rental revenue, so diversification by tenant remains quite favorable for us.

FedEx continues to be our largest tenant at 5.2% of rental revenue, which is virtually unchanged from last quarter.

Walgreens and Family Dollar are again our second- and third-largest tenants at 5% and 4.8% of rental revenue, respectively.

Walgreens is flat from last quarter, while Family Dollar is down 10 bps.

LA Fitness is 4.3%, and then all other tenants are at or below 3.1% of rental revenues.

When you get down to the 15th largest tenant, which is Walmart/Sam's Club, it represents only 1.6% of rental revenue.

And the percentages trail off from there.

We added to 55 new tenants to the portfolio this year, further enhancing our tenant diversification.

Convenience stores remain our largest industry but continue to tick down as a percentage of rental revenue.

Convenience stores now represent 10.6% of rental revenue, down from 14.9% a year ago.

Drugstores are now at 9.7%, up from 3.3% a year ago.

This was the fastest-growing industry for us in last year.

It is well aligned with our strategy of targeting high-quality, nondiscretionary retailers in attractive locations.

Restaurants, if you combine both casual dining and quick-service segments, are now at 9%, down from 12.4% a year ago.

Dollar stores are now at 7.1%, up from 4.3% a year ago.

We continue to like the deep value proposition this industry offers to our consumers in this economy, with consumers under a bit of pressure.

Health and fitness is at 6.8%, theaters are at 5.6%, and transportation services are at 5.4% of total revenues.

All other industry categories are at or below 4.3% of revenue, so we continue diversifying our rental revenues by industry.

Looking at property type, retail, as it always has, represents the primary source of our rental revenues at 77% of property revenues, with industrial distribution at 11%; office at 6.5%; and the remainder basically evenly divided between manufacturing and agriculture.

Of course, we know retail well.

We continue to focus on retail tenants that meet our investment parameters.

More than 90% of our retail portfolio has a service, nondiscretionary, and/or low price point component to their business.

We believe these characteristics better position these tenants to successfully operate in all economic environments and make them less vulnerable to Internet competition.

Regarding lease length, the average remaining lease term continues to be just under 11 years.

Same-store rents increased 1.8% during the fourth quarter, which we were very pleased with.

For the year it increased 1.4%.

This level of growth is where we expect it to continue for the remainder of the year.

Let me take a moment on tenant credit.

The credit quality of the portfolio continues to be healthy, with 40% of our rental revenue generated from investment-grade tenants.

We define investment-grade tenants as those tenants having an investment-grade rating by one or more of the three major rating agencies.

This revenue percentage is consistent with where it was last quarter, but it is up from 23.5% at the end of 2012.

Over the last four years we have established a significant foundation of revenues from investment-grade tenants at investment spreads above our historical average spreads, creating a stronger credit profile for our tenant base.

We're also pleased with the rental growth we have been able to generate from these investment-grade tenants.

70% of our investment-grade leases have rental rate increases in them which average 1.5% annually, which is consistent with our historical portfolio rental growth rate.

Moving on to property acquisitions, we completed $1.5 billion for the year at an initial yield of 7.1%.

This volume is a record, adding the $3.2 billion acquisition of ARCT that closed in January of last year, we made a total of $4.7 billion in investments.

Regarding cap rates, our policy, again, is to announce first-year cash cap rates to the market and not GAAP cap rates, which tend to be notably higher due to the straight-lining of rent.

We continue to see attractive investment spreads relative to our weighted average cost of capital.

During the year our average spread to our WACC, our weighted average cost of capital, was 155 basis points, reverting to our long-term average.

Now I would like to hand it over to Sumit, who will provide some additional color on our acquisitions activity for the quarter and for the year.

Sumit?

Thank you, John.

As John mentioned, during the fourth quarter we made $145.3 million in property-level investments in 66 properties at an average initial cash yield of 7.3%, with a weighted average lease term of 12.5 years.

62% of the revenues generated by these acquisitions is from investment-grade tenants.

These assets are leased to 21 different tenants in 16 different industries.

The most significant industries represented were discount stores, drug stores, diversified industrial, and health and fitness.

The properties are located in 28 states, and 80% of the investments are comprised of our traditional retail properties.

In 2013 we invested $1.514 billion in 459 properties at an average initial cash cap rate of 7.1% and lease term of 14 years.

65% of total rents are generated by investment-grade tenants.

These assets are leased to 32 different tenants in 23 different industries.

The most significant industries represented were drugstores, discount stores, health and fitness, and wholesale clubs.

The properties are located in 40 states.

84% of the investments are comprised of our traditional retail properties, 7% industrial, and 9% in office.

Including ARCT, we have invested $4.7 billion in 974 properties in 2013.

Regarding transaction flow, we continued the theme of seeing a record volume of transactions this year.

We sourced $39.4 billion in acquisition opportunities in 2013, of which $2.6 billion were sourced in the fourth quarter.

To put it in perspective, the $39.4 billion sourced in 2013 was more than double the volume sourced in all of 2012, which was a record year of sourcing for us.

The volume of opportunities were primarily driven by large portfolios and to entity-level transactions as compared to one-off transactions.

However, of the $1.5 billion in property-level transactions closed in 2013, over 30% or approximately $461 million were one-off transactions.

Our relationships continue to be of paramount importance to us.

Approximately 66% of the $1.5 billion in transactions closed in 2013 were relationship-driven.

As you can see, we have continued to leverage our relationships and have remained very selective in our investments, and are pursuing only those transactions that offer superior risk-adjusted returns and fit our strategic portfolio objectives.

Overall, we have been pleased with the investment results achieved in 2013.

As to pricing, cap rates have remained stable in the fourth quarter.

The stickiness of the cap rates are a testament to the amount of capital continuing to pursue transactions.

Investment-grade property cap rates range from 6.25% to 7.25%.

Non-investment-grade properties are trading from 7.25% to 8.25% cap rate.

From 2010 to 2013 we have consummated over $4.4 billion in organic acquisitions -- that is excluding ARCT -- of which 55% has been investment-grade credit and approximately 45% non-investment grade or non-rated credit.

We invested over $1.8 billion during this period in our traditional non-investment-grade retail, of which approximately $418 million was in 2013.

To put this in context, this was a more active four-year period for investments in non-rated, non-investment-grade retail than any other four-year period in our Company's history.

Our investment philosophy of pursuing opportunities that provide the best risk-adjusted returns across the credit spectrum remains consistent with our stated strategy.

For 2013 our investment spreads remained healthy.

Spreads relative to a nominal cost of equity averaged 112 bps for the year as compared to our historic average of approximately 110 bps.

For the quarter they were closer to 135 bps.

As John mentioned, looking at our investment spreads relative to our weighted average cost of capital, we average 155 bps, which is comparable to our historical average.

We have continued to make investments at historic spreads whilst improving the credit quality of the tenants and cash flows associated with those investments.

So in conclusion, we saw an exceptional level of volume in the sector and have been pleased with our $1.51 billion in investments in 2013.

Including ARCT, we invested $4.7 billion in 2013, by far a record investment year for us.

John?

Thanks, Sumit.

We recently disclosed, as you know, a $503 million acquisition of 84 single-tenant net-leased properties from Inland Diversified.

We believe this acquisition should close in three tranches during the first quarter or first four months of the year.

The first tranche of 46 properties already closed at the end of January for $202 million.

It is our policy not to announce acquisitions until after they close.

However, in this case, the seller was required to disclose the contract, so we also disclosed the potential sale.

We are subject to a confidentiality agreement with Inland that prevents us from commenting on the transaction beyond what has already been publicly disclosed in the filed 8-Ks.

As is our custom, we will address all quarterly acquisitions activity collectively on the earnings call following the quarter in which it closed.

Going to property dispositions, we continue selling select properties and redeploying the capital into investments that better fit our investment strategy.

During the year, we sold 75 properties for $134.2 million at a cap rate of approximately 7% on the sale of the leased assets.

We currently believe our dispositions for 2014 will be in the neighborhood of $50 million, possibly reaching $75 million.

Moving onto the balance sheet, as Paul mentioned, we remained conservatively capitalized, with excellent access to all forms of capital.

Currently we have more than $900 million available on our line to fund acquisitions.

We will continue to match fund our acquisitions with permanent and long-term capital, with the majority being equity.

All of our bond issuances in our Company's history -- that is 14 of them -- had a term of 10 years or longer, with the exception of one, a five-year notes issuance we did to smooth out our maturity schedule.

And outside temporary borrowings on the credit facility, 100% of our outstanding debt is fixed rate.

On to our earnings for 2013.

Normalized FFO and AFFO were both $2.41 per share for the year.

Our growth in normalized FFO per share was 19.3%, more than double our previous historical high.

And growth in AFFO per share was 17% versus 2012, also a record.

As we look forward, coming off such a good year from an operational perspective, we remain quite optimistic, as we continue to see a robust market for acquisitions with excellent investment opportunities in both non-investment-grade retail assets as well as investment-grade properties.

Over our 45-year history we have developed many relationships through which we are continuing to generate acquisition opportunities.

We are raising our acquisitions guidance for 2014 from $1 billion to $1.2 billion.

Our earnings guidance for 2014 remains at $2.53 to $2.58 per share for both normalized FFO and AFFO.

We are maintaining our earnings guidance despite the increased guidance for acquisitions due to the anticipated timing for these acquisitions.

Our dividends paid during the year increased by just over 21% compared to 2012, the largest increase in our Company's history.

In December we declared our 74th dividend increase since the Company went public in 1994.

We remain optimistic that our activities will continue to support our ability to increase the dividend.

Our payout ratio during 2013 was approximately 88% of our AFFO, which is at a level we are comfortable with.

So with that, I would now like to open it up for questions.

Danielle?

(Operator Instructions).

Juan Sanabria, Bank of America.

I was just hoping you could speak a little bit more about the trend you are seeing in cap rates.

You said they were fairly sticky in the fourth quarter, partially due to the rate of money, I guess.

Do you anticipate that to stay the case for the foreseeable future in 2014, based on what you are seeing?

And you talked a little bit about historic spreads and the spreads you got in the fourth quarter, but could you give us a sense of spot spreads relative to your cost of capital and how you are thinking about that?

First of all, with regard to cap rates, we expect them to stay pretty steady.

There is a lot of capital out there pursuing these types of assets, so we don't anticipate them climbing from here.

With regard to spreads, our spot spread, if you will, is roughly equivalent to where we were for 2013.

So at this point it looks like we're holding our spreads.

Spreads are down from their peak year of 2012.

As capital has been repriced, and there was just the subtle movement last year in cap rates, and then they'd stabilized.

I kind of missed it because it was rather quick, but the reason the guidance stayed the same, yet the acquisitions was bumped for the 2014 guidance, you said was -- if I understood correctly -- because of the timing.

But it seems like you have drawn on your revolver, implying you have done a fair chunk of the $1.2 billion year to date.

I was just curious if you could give a little bit more color, as I may have missed the details.

Yes, this based on timing.

And as you know, from the time we source a transaction to the time it actually closes can take up to six months.

So from a timing perspective, we would anticipate the additional acquisitions occurring later in the year and having more of an impact on 2015 than 2014.

And as you know, the quarters are pretty lumpy for acquisitions.

For instance, last quarter we did $145 million in a year in which we did $1.5 billion of total acquisitions.

So you can never really extrapolate from one quarter to an entire year.

So we're comfortable with the guidance where it is.

Okay.

And the drawdown of the revolver since the end of the year -- should we assume that that is related to acquisitions?

Yes.

That closed, you said -- okay, great.

Thank you, guys.

Ross Nussbaum, UBS.

My question to you would be this: if you are forecasting now $1.2 billion of acquisitions, what probability would you put on doing, say, twice that, versus -- you know, you're not going to do none.

I'm just wondering, given the robust pipeline that is out there and what you have got already locked up, do you still think $1.2 billion -- you guys have always been conservative in year guidance on that front.

I'm just sitting here wondering, are we still in an arena where you could just blow that away?

Well, we are quite selective, Ross, as you know, with what we buy.

Over the last few years we have been buying 6% to 12% of our sourced transactions.

So it is always driven by what the opportunities are; do those opportunities meet our investment parameters; and are they priced appropriately.

So they are always difficult to forecast.

Right now our best expectation is approximately $1.2 billion for organic, property-level acquisitions.

And based on what you are seeing, how much of that you think is going to be in portfolios versus more smaller one-offs?

I would say, if you were to normalize it for the end of the year, I would say about 65% to 70% would be portfolio deals.

And from a property-type perspective, what are you thinking in terms of how much of that is going to be retail versus other?

The vast majority will be retail.

Thank you.

Todd Stender, Wells Fargo.

I will start with you, Paul, just on the sourcing capital front.

Can you just comment on the preferred market -- kind of how it influences your capital sourcing activity?

I know for some time, the preferred market has been essentially closed.

And I know you guys have room in your capital stack for it.

But I wondered if -- as you look out over the next couple of quarters, how you are budgeting for your capital.

I think my comment is going to be fairly short.

Talking about the preferred market.

It is pretty opportunistic, as you know.

It is going to ebb and flow, kind of be more available at different times.

And I would have to say, as a general remark, it is not the most available market at the moment.

I only say that -- you know, you could actually do it, but relative to where you could issue and therefore have a reasonable spread really doesn't make sense.

I think best case there may be high 6s on a coupon.

And so that's not something we're really staring at at the moment.

Over time, we love preferred -- no maturity, obviously, and a great way to match-fund long-term assets like we like to.

Probably do the longer debt.

But at the moment, preferred is probably not in the cards for the foreseeable future.

Okay, thanks.

And on the same-store growth, it seemed pretty high.

It was 1.8%, and I think, John, you mentioned a little closer to 1.5%.

How did it get that high?

Usually we're used to closer to 1%.

But it has made a pretty good move.

What is contributing to this?

Well, in 2012 we were impacted by a couple of bankruptcies of Buffet's and Friendly's.

So that put a bit of a lid on it.

And it has picked back up as we have pushed through that into 2013.

The growth is coming from a number of industries: convenience stores, quick-service restaurants, beverages are all doing quite well for us.

And we think it should be around 1.5% for the year.

And that is a run rate right now we're pretty comfortable with.

Okay, just sticking with you, John, I think you mentioned this.

Can you just repeat the percentage of investment-grade tenant leases that contain annual rent escalators?

Did you say 78%?

7?

Yes, 70% of our investment-grade leases have rent growth which average 1.5% a year.

Okay, and then just -- thank you.

Just switching gears, I think you alluded to this.

But if not, can you just talk about some of the qualitative benefits that you have realized going back from your ECM portfolio acquisition, which got you into the industrial segment; and then you have got ARCT, which moved the needle for you guys into the investment-grade segment.

Items like relationships you have developed with new tenants, or maybe a first look at a sale leaseback -- anything you can share with us that you have benefited from these large portfolio transactions?

Yes, I think you hit on it.

We have really been able to multiply exponentially the number of tenant relationships we have and the opportunities for investment in terms of properties.

So one reason for the increase in the source volume activity has been net lease has been mainstreamed, so I think everybody has seen more of it.

So we are seeing more of it in retail alone, but we're also seeing more of it as the property types in which we can invest are expanded.

So we have seen more activity as a result of the acquisitions we have done and have, really, many more relationships through which to generate acquisition opportunities.

We are at a size today where we feel like we see everything in the marketplace.

And I don't think that was the case perhaps four or five years ago.

Okay, thanks.

And finally, just on the disposition front, how are you thinking about that as you look out to 2014?

Are we going to see more of the mix on vacancies, as in short-term leases?

Any property types?

Any color you can provide on dispositions?

When you look at the dispositions, we're thinking maybe $50 million to $75 million for this year.

When you look at the activity there, it is a combination of assets where we have seen, perhaps, the operating performance decline, or any areas where we would like to decrease our industry exposure, or where we have a few credit concerns.

And in a few cases there's some assets that are performing all right but just don't meet our investment strategy.

In other words, it could be a multitenant asset that we are selling.

Okay.

Thank you very much.

Chris Lucas, Green Street Advisors.

Just a quick question on dispositions and the convenience stores.

If you look at -- looking at your portfolio today, you mentioned convenience store concentration is down slightly versus Q3.

What is the right level of convenience stores and casual dining restaurants in your portfolio?

And how long do you think it will take to get there?

We're comfortable with where they are today.

We brought them both significantly down, C-stores and restaurants.

And at 10% we're comfortable.

We have selectively sold some properties in both of those sectors; but, really, our concentration levels were brought down through our growth in diversified asset pools.

But the ones that we have been watching and have been a bit concerned with, we have sold.

And we continue to look at, in particular, a couple of casual dining situations.

And then a couple of the smaller C-stores that don't produce the same sort of stores sales figures that we like to see in our investments there.

Got it, thanks.

And just one more question: just going back to the 70% of investment-grade leases that have rent bumps, could you give a breakdown of that by property type?

Yes.

The industrial distribution and office are both around 2%, and the retail is at 1.75%.

Okay, got it.

And that 70%, how much of that is, let's say, I don't know, 50% retail, maybe 30% industrial, in terms of the composition of that actual 70%?

I think retail is probably about half of it.

And then the other categories constitute the remaining half.

Got it.

Thanks, guys.

Rich Moore, RBC Capital Markets.

I am curious -- the larger line of credit, John, you have $600 million on the line of credit at the moment.

And I assume that you will be taking that out with permanent capital fairly quickly.

And then I am wondering, why the $1.2 billion?

Are you anticipating that you will need the $1.2 billion capacity?

Let me start with the first part of your question.

We have plenty of flexibility right now on the revolver.

So we have no immediate, concrete permanent capital or long-term capital plans.

So that is the first answer to your first question.

Why the size?

We like the additional liquidity and security and safety that provides the Company.

It also allows us to pursue larger transactions on a non-financing-contingent basis, which really is a competitive advantage that only a few players in the market have.

Yes, the other piece of flexibility, Rich, is the timing of a capital raise.

So kind of looking out, which, again, John said is not as imminent in terms of definitive plans we have at the moment, but being able to time the market appropriately.

Having the balance there allows you to do that.

Okay, so have you guys seen something of the size that you would need a credit line that big to take down?

Well, we have seen opportunities with all different forms and shapes and sizes.

We have seen, over the last several years, a few opportunities that would have required the vast majority of that revolver.

Okay, thanks.

And then I'm curious: on the operating expense, is that -- I am not sure why you made that change.

I think it is interesting that you did, but that's probably just more detail.

But so I guess that is a question.

Are you talking about the tenant reimbursement stuff?

Yes, putting the tenant reimbursements and breaking it out.

You know what, Rich?

I don't like it.

It's just one of those things.

It's a disclosure standpoint; it is an appropriate accounting approach, and it doesn't add anything for you guys, because these are basically expenses that we do get reimbursed for.

We don't have major outstanding receivables related to them, or anything like that.

So it just flows straight through.

The issue was they'd just gotten to be a little bit more in size.

So once they reached a little bit more of a material amount, which is now about $25 million annually, it was prudent to break it out as an additional disclosure.

But wanted to make sure I was highlighting to you -- don't count that in the revenue line, and forget about the fact that it offsets immediately down the expense line.

Right, okay.

I got you, Paul.

And so when you are looking at the small operating expenses, just the operating expenses that aren't reimbursed, A, it went down a little bit this quarter.

And it's just not a huge number to begin with, but it went down a little bit.

And remind me: is that just the vacant assets?

Or do you guys have some -- some of the multitenant or double net-type leases or something like that that is also part of that?

No, it is both.

Historically it was primarily carry costs on the vacant properties -- taxes, insurance, utilities.

But over the last 18 to 24 months, we have purchased more properties with a double-net structure, where we have some responsibilities for roof and structure.

And as such, that is budgeted in there as some additional property expenses.

Still only $16.5 million budgeted for next year on what is a current run rate of $819 million of annualized revenue.

So still not a huge number, but it has gone up a bit in the past few years.

Okay, good, thanks.

And then the last thing.

That other revenue line item, which I know has a couple of crazy things in it -- do you guys have an estimate for what that might be?

Or is there just no way to do that?

The way I always answer that is don't put zero in, because something always ends up there -- easements, property takings -- which could be an eminent-domain grab of some property line, if they widen the highway.

It is kind of free money, if you will.

In many cases, not impinging on your parking or things of that nature.

And then interest income, if you have cash that is received early that you're putting away in the bank briefly for some income, or you have raised something on an offering that you haven't used for a day or two.

So just ends up being something.

So my only advice is to not put zero in, but I hate to give a number.

But there's always going to be something there.

Okay, good, great.

Thank you, guys.

Emmanuel Korchman, Citi.

Emmanuel Korchman What do you guys think about the investment spreads that you have been quoting in the spreads to your weighted average cost of capital?

Do you think about that with permanent financing or using the line as sort of -- especially in some of that spot investment stuff?

No, we're looking at it based on permanent financing using roughly two-thirds equity, one-third 10-year fixed-rate notes.

Got it.

And then if we think about the pipeline of stuff you have looked at and maybe passed on -- I think you have quoted numbers around $60 billion over the last couple of years.

How much of that has ended up in either public or other known hands?

And how much was just pulled from the market?

I would say a significant portion has ended up in the hands of public or private.

So we see a lot of it.

In terms of the exact breakdown -- Sumit?

You are right, John.

I would say a majority of them have ended up in either public or private hands.

But there have been occasions on large, very large transactions that we are aware of where those transactions were pulled.

Yes.

And was it mostly a pricing thing that it ended up that you guys passed on it, or were there other considerations?

It was -- the situations that I am alluding to were all driven by pricing considerations.

Great.

That is all for me.

Thank you.

Todd Lukasik, Morningstar.

It is Todd Lukasik.

Thanks for taking my questions today.

Just a question on office -- 6.6% of revenues, it looks like.

And there was some of them that made it into the portfolio again this past quarter.

I think in the past you guys have talked about that not being one of your favorite property types.

I am wondering if there is anything in particular about the assets that you are buying there that are especially attractive, or if sellers are requiring that those be included in deals, or if there is any change in thinking around those office properties?

Well, the office assets -- we are typically acquiring office properties that are part of larger portfolios of retail and industrial and distribution properties.

That is not always the case.

At times we will extend our relationship, for instance, with some of the retail tenants by purchasing their office or industrial properties, as well.

So we will see some activity from those areas.

But our objective is to keep office fairly low as a percentage of our overall property rental revenues.

And are some of those coming on the balance sheet because the seller is requiring that they be part of the deal?

No.

No, not necessarily.

Like John said, sometimes they are in a larger portfolio, meaning a sale leaseback transaction is already affected by another sale leaseback provider, and this is part of a portfolio; or it is a direct conversation with a strong long-term retailer relationship where they have asked us to take a look at, say, their headquarters location as an asset we would consider doing something with.

But not forcing it on us as part of a larger deal in dialogue.

Got you.

Okay, that's helpful.

And then just with regards to the AFFO coverage of the dividend, with more industrial and distribution facilities, office assets on the balance sheet, as those things expire -- if the tenant doesn't renew, there may be more leasing costs or CapEx that needs to be put into some of those properties to find a new tenant.

Is that the kind of thing that might cause you to think to lower the AFFO payout ratio over time as those leases start to roll?

Or is that -- you're comfortable with sort of 88% level in light of those possible incremental costs down the road?

I think over time we would like to see it be a bit lower.

Somewhere in the mid-80s is a level we think we would be comfortable with.

But having said that, we will continue to grow the dividend as it relates to our overall earnings growth.

So if you're talking about X percent of growth, then we're going to be trying to grow the dividend 0.8X, or whatever it might be, to try to move that payout ratio down a little bit over time.

But it will certainly result in what we think will be dividend growth.

It will be amenable to and helpful to the investor from a return perspective over time.

Okay.

Got you.

That is helpful.

Thanks a lot, guys.

Jonathan Pong, Robert W. Baird.

Sumit, I think you mentioned earlier there is a 65%/35% split between portfolio and single-tenant deals for 2014.

Does that 65% include the Inland deal?

Or are you just saying going forward of the deals yet to be announced it is going to be a 65% portfolio?

Jonathan, that was a backward-looking.

That was for 2010 through 2013.

So it didn't, obviously, include the Inland transaction, which hasn't closed -- which didn't close until 2014.

Got it.

So for 2014, where do you think that split ends up?

You know, it is going to be similar.

I think there was a question asked around where do we see a lot of our volume composition -- how do we see our volume composition on the acquisition side?

And I still believe that the big, chunkier transactions drive volume.

And that will represent 65% to 70% of it.

And in terms of investment-grade versus non-investment-grade, it's going to be a function of our cost of capital and what we see in the market.

There was a repricing of our cost of capital, which allowed us to look at areas that we have traditionally been pursuing to get the kind of spreads that we have been able to trap.

And so I could see it being right around that 50% to 60% investment-grade for 2014, as well.

But it could be different.

All right, Thanks.

And Paul, maybe a balance sheet question.

On the Inland purchase, I know there is some debt that you are assuming there.

On the tranches that have yet to close, how much more of the revolver is Inland going to take up?

Well, as you know, with $202 million at the end of January closed, and some of that involved assuming mortgages -- about $50 million or so.

So you kind of do the math from there.

Because on a $500 million transaction, the mortgage amount on it is about $150 million.

So $100 million is assumed out of the $300 million left to close.

So, say, $200 million is needed on the facility to ultimately close the balance of the Inland transaction.

Great.

That is helpful.

Thanks a lot.

Chris Lucas, Capital One Securities.

John, I just wanted to see if you could give some more color on the acquisition environment.

And in particular, I guess what I'm trying to understand is where the most competitive size of deal is.

Is it the one off?

Is it the small portfolio of deals?

Is it the large portfolio of deals?

Where is the market most competitive right now?

It is most competitive on larger portfolios, where -- you are definitely seeing still in this market premium cap rates, lower cap rates for the same asset in a $300 million portfolio transaction than you would see in a one-off asset transaction.

And again, I attribute that to the fact that there is a fair amount of capital in our industry and business, and to deploy it efficiently and quickly warrants a premium paid for the assets at times.

So we do see that spread.

All things being equal, an asset acquired on a one-off basis is going to have a higher cap rate than one acquired in a larger portfolio.

However, that is not universally the case.

But that is certainly the trend, Chris.

And then just a question.

Is the 1031 market recovering at all?

Is there much activity coming from that one-off buyer, that small, individual tax-incented buyer?

There is more activity -- we saw more activity in 2013 than we did in the previous few years combined, probably.

So it has come back.

It's still not back to where it once was pre-Great Recession, but we're seeing more activity there.

So what do you think changes that momentum?

Is it financing availability, or alternative investments?

What do you think is --?

How about gain?

Yes, this is a bit more of an aggressive investment environment than you've had.

Again, people are getting their feet under them and feeling a bit more confident, even though the economic signals appear to be mixed.

You're just seeing more people willing to transact in that marketplace.

Okay, thanks a lot, guys.

Appreciate it.

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

I will now turn the call over to John Case for concluding remarks.

Thanks, Danielle.

And thanks, everyone, for joining us today.

We appreciate your time and look forward to speaking with you again next quarter.

Take care.

Ladies and gentlemen, that does conclude the conference call for today.

Thanks again for your participation, and you may now disconnect.