Realty Income Corp (O) 2014 Q4 法說會逐字稿

Good day and welcome to the Realty Income fourth-quarter 2014 operating results conference call. Today's conference is being recorded. At this time I'd like to turn the conference over to Ms. Janeen Bedard. Please go ahead, ma'am.

Thank you all for joining us today for Realty Income's fourth-quarter 2014 operating results conference call. Discussing our results will be John Case, Chief Executive Officer; Paul Meurer, Chief Financial Officer and Treasurer; and Sumit Roy, Chief Operating Officer and Chief Investment Officer.

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 any forward-looking statements. We will disclose in greater detail the factors that may cause such differences in the Company's Form 10-K. I will now turn the call over to our CEO, John Case.

Thanks, Janeen, welcome to our call today. We are pleased with our fourth-quarter results with AFFO per share increasing by 4.8% to $0.65 and 2014 AFFO per share increasing by 6.6% to $2.57. As announced in yesterday's press release, we are reiterating our 2015 AFFO per share guidance of $2.66 to $2.71 as we continue to anticipate another solid year of earnings growth. Paul will provide you with an overview of our financial results. Paul?

Thanks, John. As usual I will briefly comment on our financial statements and provide some highlights of our financial results for the quarter and the year starting with the income statement.

Total revenue increased 14.5% for the quarter and 19.6% for the year. This increase reflects our growth primarily from new acquisitions over the past year as well as same-store rent growth. Our annualized rental revenue at December 31 was approximately $920 million.

On the expense side depreciation and amortization expense increased to $96.5 million in the quarter as depreciation expenses obviously increased with our portfolio growth. Interest expense increased in the quarter to $59.1 million. This increase was primarily due to our two recent bond offerings, the $350 million 10-year notes we issued in June and the $250 million 12-year notes issued in September.

On a related note, our coverage ratios both remain strong with interest coverage at 3.8 times and fixed charge coverage at 3.4 times. General and administrative, or G&A expenses were approximately $15.6 million for the quarter and $51.1 million for the year. Both were decreases from last year due to lower acquisition transaction costs as well as lower stock compensation costs.

Overall our total G&A in 2014 as a percentage of total rental and other revenue represented only 5.7% of revenues. Our projection for G&A expenses in 2015 is approximately $55 million or about 5.5% of revenues.

Property expenses, which were not reimbursed by tenants, totaled $4.2 million for the quarter and $16.8 million for the year. Our current projection for property expenses that we will be responsible for in 2015 is approximately $20 million.

Income taxes consist of income taxes paid to various states and cities by the Company and they were approximately $1.1 million for the quarter and $3.5 million for the year.

Provisions for impairment of approximately $2 million during the quarter includes impairments we recorded on one sold property and two properties held for sale at December 31. Note that approximately $510,000 of this impairment is recognized in discontinued operations on the income statement, an accounting treatment that is necessary because the property was held for sale at the end of last year when the disc ops accounting rules changed.

Gain on sales were approximately $25 million in the quarter and $42 million for the year. And just a reminder, as always, we do not include property sales gains in our FFO or AFFO. Funds from operations, or FFO, per share was $0.64 for the quarter, a 4.9% increase versus a year ago, and $2.58 for the year, a 7.1% increase over 2013.

Adjusted funds from operations, or AFFO, or the actual cash we have available for distribution at dividend was $0.65 per share for the quarter, a 4.8% increase versus a year ago, and came in at $2.57 for the year, a 6.6% increase over 2013.

Dividends paid increased 2.1% in 2014 and, as previously announced, last month we declared a 3% increase to our cash monthly dividend which was paid to shareholders this month. Our monthly dividend now equates to a current annualized amount of approximately $2.268 per share.

Briefly turning to the balance sheet, we have continued to maintain our conservative and safe capital structure. As previously disclosed, we redeemed our $220 million of preferred E stock which had a coupon of 6.75% back in October.

Recall that in mid-September we issued $250 million of 12-year bonds priced at a yield of 4.178% to pre-fund this preferred redemption. This transaction overall resulted in annual cash expense savings of almost $5.7 million. Obviously we are pleased with our continued access to low-cost long-term capital and the bond market.

Our bonds, which are all unsecured and fixed rate and continue to be rated Baa1, BBB+, have a weighted average maturity of 7.2 years. Our $1.5 billion acquisition credit facility had a $223 million balance at December 31 and currently we have $382 million of borrowings on the line.

We did not assume any mortgages during the quarter. We did pay off some at maturity, so our outstanding net mortgage debt at year end decreased to approximately $836 million.

Not including our credit facility the only variable rate debt exposure to rising interest rates that we have is on just $39 million of this mortgage debt. And our overall debt maturity schedule remains in very good shape with only $120 million of mortgages and $150 million of bonds coming due in 2015 and our maturity schedule is well laddered thereafter.

Currently our debt to total market capitalization is approximately 30% and our preferred stock outstanding is less than 2.5% of our capital structure. And our debt to EBITDA at yearend was only 5.8 times. Now let me turn the call back over to John who will give you more background.

Thanks, Paul. I will begin with an overview of the portfolio which is performing well and continues to generate a tenable cash flow for our shareholders.

Occupancy increased 10 basis points from last quarter and 20 basis points year over year to 98.4% based on the number of properties, with 70 properties available for lease out of over 4,300 properties in our portfolio. This is the highest our occupancy has been since 2007.

Occupancy based on square footage was 99.2%, a 10 basis points improvement from last quarter and 20 basis points year over year. Economic occupancy was also 99.2%, a 10 basis point improvement from both last quarter and year over year.

2014 has been one of our most active years ever for lease rollover activity with leases expiring on 220 properties. Of these properties we re-leased 173 to existing tenants and 30 to new tenants, recapturing 99.3% of expiring rents on the properties that were re-leased. In addition, we sold 17 vacant properties during the year.

In the fourth quarter we experienced 54 lease rollovers. Of these we re-leased 40 to existing tenants and 10 to new tenants, recapturing approximately 97% of expiring rents on the properties that were re-leased. Eight vacant properties were sold during the fourth quarter.

Our same-store rent increased 1.7% during the quarter and 1.5% in 2014. The industries contributing most to our quarterly same-store rent growth were convenience stores, health and fitness and quick service restaurants. We expect same-store rent growth to remain at about 1.5% for the foreseeable future.

Our portfolio continues to be diversified by tenant, industry, geography and to a certain extent property type. At the end of the fourth quarter the properties were leased to 234 commercial tenants in 47 different industries located in 49 states and Puerto Rico. 79% of our rental revenue is from our traditional retail properties, while 21% is from non-retail properties, the largest component being industrial and distribution.

This diversification continues to enhance the predictability of our cash flow. We continue to focus on retail properties leased to tenants with a service, nondiscretionary and/or a low price point component to their business. Today more than 90% of our retail revenues come from businesses with these characteristics which better position them to successfully operate in all economic environments and to compete with e-commerce.

At the end of the fourth quarter our top 10 and top 20 tenants represented 37% and 53% of rental revenue respectively. The tenants in our top 20 continue to capture nearly every tenant representing more than 1% of our rental revenue.

There were no changes to the composition of our tenants in our top 25 since last quarter. None of the top 20 tenants have investment grade credit rating. The rental revenue from these non-investment-grade rated tenants represents over half of the rent from our top 20 tenants.

Within our portfolio no single tenant accounts for more than 5.4% of our rental revenue, the diversification by tenant remains favorable. Walgreens continues to be our largest tenant at 5.4% of rental revenue, unchanged from last quarter. FedEx remains our second largest tenant at 5.1% of rental revenue which is also unchanged from last quarter.

Convenience stores remain our largest industry at 9.8% of rental revenue, down 20 basis points from last quarter. Our second largest industry is dollar stores at 9.5%, down 10 basis points from last quarter.

As many of you know, the competition between Dollar Tree and Dollar General, the purchase of Family Dollar recently ended with Family Dollar shareholders approving a merger with Dollar Tree. Family Dollar is our fifth largest tenant at 4.5% of rental revenues. We view this outcome as an incremental positive given the minimal portfolio overlap Family Dollar has with Dollar Tree and there will be no impact on our tenant diversification metrics.

The FCC is currently reviewing the merger, but we remain confident that the performance and long lease duration of our Family Dollar locations should ensure that the divestitures have no impact on our rental revenue.

We continue to have excellent credit quality in the portfolio with 46% of our rental revenue generated from investment grade rated tenants. Again, we define an investment grade rated company as having an investment grade rating by one or more of the three major rating agencies. This revenue percentage is up from 40% a year ago.

We continue to generate solid rental growth from these investment grade tenants. Nearly 70% of our investment grade leases as a percentage of rental revenues have rental rate increases in them which average approximately 1.4% annually, which is consistent with our historical portfolio rental growth rate. Overall investment grade tenant rental growth is about 1%.

In addition to tenant credit, the store level performance of our retail tenants remains positive. Our weighted average rent coverage ratio in our retail properties is 2.6 times on a four wall basis and, importantly, the median is 2.7 times.

Moving on to acquisitions. We continue to see a very high volume of sourced acquisition opportunities. During the quarter we sourced nearly $4 billion in acquisition opportunities and for the year we sourced $24 billion, making this our second most active year ever for sourced transactions.

There continues to be a lot of capital pursuing these transactions and we continue to remain selective in our investment strategy, investing at attractive risk adjusted returns and investment spreads for our shareholders.

During the quarter we completed $158 million in property level acquisitions at a cash cap rate of 7.1%, bringing us to $1.4 billion in acquisitions for the year at an initial cash cap rate of 7.1% as well.

Our investment spreads relative to our weighted average cost of capital continue to be well above our historical average. Today we are investing in spreads over 250 basis points above our weighted average cost of capital.

Given the active environment we are seeing we are raising our 2015 acquisitions guidance. We now expect acquisitions volume of $700 million to $1 billion, an increase from our initial acquisitions guidance for the year of $500 million to $800 million.

As expected we had a very active quarter of dispositions as we sold 18 properties for $53 million during the fourth quarter. During the year we sold 46 properties for $107 million, more than double our initial expectation of $50 million at the beginning of the year. And we are again reiterating our initial disposition guidance for 2015 of approximately $50 million.

Now let me handed over to Sumit to discuss in more detail our acquisitions and dispositions. Sumit?

Thank you, John. During the fourth quarter of 2014 we invested $158 million in 82 properties, approximately $1.9 million per property, located in 26 states at an average initial cash cap rate of 7.1% and with a weighted average lease term of 14.6 years.

As a reminder, our initial cash cap rates are cash and not GAAP which tend to be higher due to straight lining of brands. We define cash cap rates as contractual cash net operating income for the first 12 months of each lease following the acquisition date divided by the total cost of the property including all expenses borne by Realty Income.

On a revenue basis 32% of total acquisitions are from investment-grade tenants and 68% of the revenues are from non-investment-grade retail tenants. 87% of the revenues are generated from retail and 13% are from industrial and distribution. These assets are leased to 23 different tenants in 19 industries. Some of the most significant industries represented are quick service restaurants, grocery stores and drugstores.

For the year 2014 we invested $1.4 billion in 506 properties, which equates to approximately $2.8 million per property, located in 42 states at an average initial cash cap rate of 7.1% and with a weighted average lease term of 12.8 years.

Of the total amount approximately $434 million was invested in non-investment-grade retail properties. On a revenue basis 66% of total acquisitions are from investment-grade tenants. 86% of the revenues are generated from retail, 8% are from industrial distribution and manufacturing and 6% are from office.

These assets are leased to 62 different tenants in 32 industries. Some of the most significant industries represented are dollar stores, home improvement and drugstores. Of the 80 independent transactions closed in 2014, only three transactions were above $50 million.

Transaction flow continues to remain healthy. We sourced approximately $4 billion in the fourth quarter. For 2014 we have sourced more than $24 billion in potential transaction opportunities. 2014 was the year with the second largest volume sourced in our Company's history. Of these opportunities 82% of the volume sourced were portfolios and 18% or approximately $5 billion were one off assets.

Investment-grade opportunities represented 49% for the fourth quarter. Of the $158 million in acquisitions closed in the fourth quarter approximately 33% were one-off transactions. 88% of the transaction closed in the fourth quarter were relationship driven.

We remain selective and disciplined in our investment approach closing on less than 6% of deals sourced. And continue to capitalize on our extensive industry relationships developed over our extended operating history.

As to pricing, cap rates remained tight in the fourth quarter. With investment grade properties trading from low 5% to high 6% cap rate range and non-investment-grade properties trading from high 5% to low 8% cap rate range.

As John highlighted, our disposition activities remained active. During the quarter we sold 18 properties for $53.4 million at a net cash cap rate of 5.7% and realized an unlevered IRR of just over 12%.

For 2014 we sold 46 properties for $106.6 million at a net cash cap rate of 6.9% and realized an unlevered IRR of 11.6%. Our investment spreads relative to our weighted average cost of capital were very healthy, averaging 211 basis points in the fourth quarter and 195 basis points in 2014, which was significantly above our historical average spread. We define investment spread as initial cash yield less a nominal first year weighted average cost of capital.

In conclusion, the fourth-quarter investments remain solid at $158 million. For the year 2014 we invested $1.4 billion while sourcing more than $24 billion in transactions. Our spreads remained comfortably above our historical level as a tight cap rate environment in the fourth quarter was more than offset by improving cost of capital.

We continue to be very selective and pursuing opportunities that are in line with our long-term strategic objectives and within our acquisition parameters. We also took advantage of an aggressive pricing environment to accelerate dispositions of assets that are no longer a strategic fit.

As John mentioned, we are raising our acquisition guidance for 2015 from $500 million to $800 million to $700 million to $1 billion. With that I would like to hand it back to John.

Thanks, Summit. We continue to generate healthy per share earnings growth while maintaining a conservative capital structure. Our fourth-quarter FFO and AFFO per share of $0.64 and $0.65 represented increases of 4.9% and 4.8% respectively from a year ago. Our 2014 FFO and AFFO per share of $2.58 and $2.57 represented increases of 7.1% and 6.6% respectively from a year ago.

We are reiterating our 2015 FFO per share guidance range of $2.67 to $2.72, an increase of 3.5% to 5.4% over 2014 FFO for share. As mentioned earlier, we are also reiterating our AFFO per share guidance of $2.66 to $2.71, an increase of 3.5% to 5.4% over 2014 per share figures.

Our focus continues to be the payment of reliable monthly dividends that grow over time. We have increased our dividend every year since the Company's listing in 1994, growing the dividend at a compounded average annual rate of 4.7%.

Our track record was recognized last month with our addition to the S&P High Yield Dividend Aristocrats Index, which measures the performance of companies in the S&P composite 1,500 that have increased their dividend every year for at least 20 consecutive years. We are one of only six REITs included in this index and we remain committed to consistent growth of the dividend.

Our payout ratio is 84.5% based on the midpoint of our 2015 AFFO guidance which is a level we continue to be comfortable with. This compares similarly with our 2014 AFFO payout ratio of 85.3%.

Finally, to wrap it up, we are pleased with our performance for 2014 and we remain quite optimistic for 2015. As reflected in our increased acquisitions guidance, we continue to see healthy volumes of acquisition opportunities, but we will remain selective and disciplined with our investment strategy.

We remain well-positioned to execute on opportunities with just over $1.1 billion available in the credit facility today. Additionally, our cost of capital advantage continues to support our ability to drive healthy earnings accretion for our shareholders. At this time I would now like to open it up for questions. Operator?

(Operator Instructions). Juan Sanabria, Bank of America.

Just a question on the strategy with regards to your industrial exposure. How should we be thinking about that either growing or staying the same as a percentage of the pie going forward? And what kind of pricing are you seeing for those assets specifically? And is it really just still an investment-grade focus on those types of assets?

Yes, Juan, we continue to focus on exclusively investment-grade industrial. And at the end of the year last year we had about 14% of our acquisitions came from industrial and distribution. We are still predominantly retail, 86%.

We are seeing a bit of cap rate compression in the market place and that includes industrial. But we are actively seeking Fortune 1000 tenants with investment-grade ratings and mission-critical or significant locations with investments at or around replacement cost, at or around long-term -- at or around market rents with growth with a long-term lease.

So that is typically the profile of what we are seeing and cap rates for that product range from probably the mid-5%s right now to the high 6%s. We will continue to do that, but it will represent a minority of our investment activity.

Okay, should it grow as a piece of the pie or it kind of holds steady from the current levels?

Right now it is holding steady and I think over the near to intermediate term it will hold steady to grow a slight bit.

Okay, thanks. And I just wanted to ask about the increase in your acquisitions guidance. Is there anything in particular that drove that? Are you feeling or seeing more portfolio deals or is it more one-off relationship transactions?

And as sort of a tangential follow-up, I think you noted the fourth quarter had some quick service and restaurant deals. From memory I think you guys have been a little bit cautious on casual dining restaurants. Any change of tact there maybe with the lower oil price or is it just specific to those deals in the fourth quarter?

With regard to QSRs, we have been buying those for quite some time. This Company started in 1969 with an investment in a Taco Bell. And over the last five years we have invested $2.2 billion in noninvestment grade retail where we are underwriting to four wall cash flow coverages, quality tenants, high traffic quality locations. And we have never gotten away from that business.

We supplemented it with the investment-grade strategy but we continue to be very active, the most active we have been in our history over the last five years in buying noninvestment grade retail. So we will continue to do that going forward.

As far as acquisitions guidance, the first part of your question, we are seeing both more one-off and small portfolio sourcing opportunities as well as some larger portfolios. So the driver in our acquisitions guidance change has been more activity, continued risk, sourcing activity, it has given us more confidence for the year and therefore we have raised the midpoint of our acquisition status by $200 million.

I will add that we did not adjust our AFFO per share estimates because we believe this activity -- incremental activity will be back end loaded and will have more of an impact in 2016 than 2015.

Thanks, John. I appreciate the color.

Todd Stender, Wells Fargo.

Just to get a sense of any trends that stick out for the $4 billion of source deals that you looked at in Q4, what was the mix of property types, and any characteristics maybe you can point to? And was any of this located overseas, maybe what your appetite is for international right now?

Yes. So virtually all of it was domestic. And 90% of it was retail properties. So that will give you a good overview of what the sourcing activities look like. Sumit, do you have anything to add on that front?

No. And there was a large portfolio that we saw that had some international assets there as well, but it was a very small piece of the pie -- of the $4 billion.

Okay, that is helpful. And just looking at the sources of capital right now. You tapped the stock purchase plan and DRIP I believe might be in there too for $100 million in the quarter. Is this truly a capital source? Should we be thinking about your ability to maybe tap $100 million a quarter if your stock performs well?

It is something we implemented about a year and a half ago, the waiver discount program, and it has been very successful for us. We did issue $100 million in the fourth quarter; we also did a little bit of activity on our DRIP as well.

Going forward it is something that we will opportunistically access; it is an efficient way for us to raise equity. The cost of that equity is about 1.3% versus a little over 6% for a regular way offering. So it is cheaper for the Company and it allows us to sort of match fund some of our acquisition activity.

So we will continue to utilize it where it makes sense in the future. But we would also -- won't abandon regular equity offerings.

Is there an authorization for that, John, or is there a limit of how much you can do or does the Board weigh in on how much they want to issue?

Yes. The Board has to authorize it and they have and we have authorization for up to 6 million shares which should last us for a while.

Okay, that's helpful. And I may have missed this getting on late, but what is holding you back from increasing your guidance given the $200 million increase in your acquisition guidance?

Yes, I was just talking to Juan about that, it is really timing. The incremental acquisitions we believe will close late -- the latter part of 2015. So they will have a greater impact on 2016 AFFO and FFO versus 2015. So we felt comfortable leaving our guidance where it is.

Great, thank you.

Rich Moore, RBC Capital Markets.

I am curious on the line of credit. You guys added $150 million, was that just to pay off mortgages that came due? Is that what that was?

No, it -- it would be (multiple speakers).

Since the end of the quarter, Paul.

What is that? Since the end of the quarter. Yes, no, it is primarily (multiple speakers) it would be primarily used for acquisitions during the first quarter.

Okay, so that was $150 million of additional acquisitions. And do you have additional acquisitions under contract?

Yes, we do.

Okay, great. Thanks. And then I was curious, guys, the development and expansion properties, I know it is not terribly many, but it looked like you delivered nine in the quarter. Did I read that right out of the supplemental?

And then how do you think about these properties going forward? Will the 14, it seems, that are left -- will those just get finished and go away and you don't have any more of these coming or do you do this periodically?

No. We like to maintain a fair amount of activity in that effort. The returns are about 150 basis point higher in terms of initial yields and what we realize on acquisitions. Currently we have $45 million in development underway of which we funded just over $12 million of that. About half of that is new development; about half of those assets are redevelopment and expansion of existing properties.

But it has been a very attractive business for us from a return standpoint. And we'd actually like to see that, Rich, grow to a couple hundred million, which we think is just fine on a balance sheet of our size, $16 billion in assets.

Okay, got it, John. Thanks (multiple speakers).

I was just saying it will be a consistent theme of the business and continue.

Okay, great. Thank you. So did you deliver [$9 million] in the quarter, is that right? Did I understand that correctly when I look at the supplemental?

Yes -- Sumit.

Yes, part of it is we are constantly putting in redevelopment dollars. So at any given time I think there were 23 assets for the quarter where we invested those $13 million. But in terms of actual delivery, those would only take into account new development and we don't actually have that stat in front of us.

Okay. So when you talk new development, by the way, you are talking build to suits I assume?

That is exactly right.

Yes, I mean it is important to note that all of these have tenants in place and none of this is speculative development.

Okay, and who are the kinds of tenants typically, just out of curiosity?

Well, it ranges from some of our health club tenants, our distribution sector tenants, some general merchandisers and a couple of theaters on the expansion and redevelopment side.

Okay, great. Thank you very much, guys.

Vikram Malhotra, Morgan Stanley.

Just a quick question on competition. Some of your peers have mentioned more comp -- or increasing levels of competition from some of the non-traded folks over the last few months. Just wondering if you are seeing any incremental or maybe even lower competition at kind of the granular side and maybe in the portfolios -- or maybe on the portfolio side in terms of [equity]?

Yes, we have had a couple -- one major player obviously step back from the market and they played at the granular level as well as on larger portfolios. So we are seeing a bit of an impact from that, but nothing too significant.

What we have seen is more foreign institutional capital come into the market and really with greater debt than we have seen return of the 1031 buyer. So the individual buyers are much more active today for granular assets and more aggressive than they were just a year ago.

So some of what we have seen go away from -- the non-traded's aren't quite as active as they were a year ago. It has kind of been offset mostly but not entirely by the return of the 1031 buyer and more foreign institutional money coming into the sector on the higher-quality properties.

Okay, thanks. And then just on your watch list, we have heard in the retail space in general, whether it is in strips or in malls, that there have been some tenants that have been under pressure, some have closed stores. I am just wondering if your watch list has changed in any way perhaps by category or any tenant over the last quarter or so.

Not really. When you look at our watch list you have a pretty healthy portion of that coming from two industries and that is casual dining and child day care. Our watch list continues to represent about 1.5% of our revenues; that is not that large. And as we watch those properties we will make decisions whether to sell those, leave them on the watch list or return them to the portfolio -- the regular portfolio.

So we haven't really seen any changes in the composition. I will say that overall the tenant base continues to perform quite well. There's enough economic growth activity out there, the consumer is in better shape. We really by and large have no significant tenant issues right now. So they are as healthy as they have been in quite some time.

Okay, thank you.

Nick Joseph, Citigroup.

Appreciate the color on the updated acquisition guidance. What does guidance assume for the cash cap rates and investment spreads for the 2015 acquisitions?

Yes, on the initial yields, cash yields of right around 7%. And on the investment spreads we are assuming something consistent with what we did last year. So averaging right around 195 basis points.

Great, thanks. So then across your portfolio what do you expect the net impact of lower oil prices to be on your tenants?

We are actually seeing a little of that. We have had decent percentage rents at the end of last year and early January. We're seeing the consumer with more disposable income spending that. While we do own convenience stores, about 9.8% of our rental revenues are from convenience stores.

They continue to perform well and their inside sales have ticked up which is where their margin is and where they make most of their money. On gasoline sales their profit is fairly fixed irrespective of price. So the C-store portfolio continues to perform well.

So we are seeing it, I think we will continue to see it as long as these prices hold where a little extra money in the pockets of consumers will help, be it the dollar stores, the C-stores, some of these other areas.

Great, thanks.

(Operator Instructions). Cedrik Lachance, Green Street Advisors.

When I look at your cap rates throughout the year in 2014, they remain relatively stable. They have always been around give or take 7% on the acquisitions. By contrast the investment grade tenancies that were acquired in each quarter declined, so from 85% to 30% from the first quarter to the last quarter.

Would you say that you are purposefully trying to keep your initial yields around 7% and therefore are now willing to do more noninvestment grade rated tenants? Or is it just a function of what was on the market during the year?

It is a function of what is on the market and which assets are offering the best risk adjusted returns. When you look at pricing it is not only impacted by investment-grade or non-investment-grade, it is also impacted by how much development did we do in the period, what are the average lease terms.

So you look at the fourth quarter and you will see lease terms that were longer than they were in the third quarter. And that is reflected in the cap rate, the longer lease terms are going to be at more aggressive cap rates. And then on the development side it constituted more activity in the third quarter and that is reflected -- those are higher yields and that is reflected in our average cap rate for the third quarter.

So it is really hard to sort of extrapolate trends there because the mix shifts each quarter. I think it is better to look at the long-term trend. While we did see some cap rate compression last year towards the end of the year it kind of -- it slowed down, Cedrik. So, I think that 7% on average is going to hold right around there for the first part of 2015.

Okay. So you talked about foreign capital entering the fray or being more interested in the higher-quality properties. Have you thought about forming joint ventures with that capital in order to go after some of those lower yielding assets?

We haven't approached any of them at this point. I think what you are seeing is a lot of capital looking for yield flowing into the US, some of it is coming into the sector. And there is a fair amount of that capital to deploy. So I am not sure they are looking -- these are well-heeled sovereign wealth funds and other foreign institutions that don't really need a capital partner.

But they may need an operating partner or a partner that may identify acquisitions a lot better than they can. Is there a role for you to play?

Yes, most of these are working through US-based institutional investment managers that run net lease money. So they bought these properties before they sourced them, they identified them. So they are not working without a US advisor.

And the fact that it is net lease, they don't feel that they need as much of an operating partner as they would if they were in a more actively managed portion of the real estate business. But it is something that could make sense at some point.

Okay. And then just a final question in regards to your cost of capital. I think your investment spreads versus where you have been able to invest historically are certainly at a high point or very close to a high point. By contrast I'd say your acquisition guidance for 2015 is fairly conservative.

Given that the spread is so wide or at least so wide as it is today, why not be a very aggressive buyer at this point in time and capture the benefit of that spread in large numbers?

Well, our consistent theme has been to remain disciplined with regard to our investment strategy. And so, we are really pursuing assets that fit our investment strategy. We are talking about 10-, 15-, 20-year leases and we want assets that are going to perform well over the long run and not necessarily just offer an attractive spread today that potentially would be an issue down the road.

So we see transactions getting done that are aggressively structured from a pricing, coverage, replacement cost, market rent standpoint. And we are not going to chase those transactions because we think there is some risk and downside in the intermediate term and longer-term to those types of transactions.

So we are really approaching it with a long-term view here and we think our investment strategy is something that will serve the Company well over the long run. So clearly given our cost of capital advantage relative to the rest of the sector and our availability of capital we could acquire a lot more than we are acquiring. But again, we don't want to deviate from the assets that make the most sense for us and we don't want to get overly aggressive on the structures either.

Okay. Thank you.

Todd Lukasik, Morningstar.

I just had a question on re-leasing activity. And I am assuming in the quarter and in the year that was all retail assets. I guess it looks like around 2018 you will start to see more of the non-retail assets up for renewal. I was just wondering if you guys had any expectations at that time in terms of what will happen to re-leasing spread, if you expect it to stay the same or maybe go up or go down a little bit?

Well, we would expect the leasing spread to be similar to what we have in the existing portfolio, maybe a little bit higher. We get our first in 2018 I think it is, our first non-retail property role. And I think that as we do our long-term planning, long-term budgeting we are assuming a recapture rate of right around 100% we would hope that it would be a little north of that, Todd. But we will see when we get there.

Okay. And then just a question with the re-leasing to the new tenants. Is it fair to assume that the majority of those leases that do end up going to new tenants are leases that are up for initial renewal as opposed to subsequent renewal or is that something that is spread out across both of those?

It is a little bit weighted towards initial renewals, yeah.

Okay.

That is a good assumption, yeah.

All right, okay, great, that is all I have. Thanks.

This concludes the question-and-answer portion of Realty Income's conference call. I will now turn the call over to John Case for concluding remarks.

Thanks, Taylor, and thanks, everyone, for joining our call today. We look forward to speaking to you at some of these conferences coming up over the next few months. Have a good afternoon.

This concludes today's conference. Thank you for your participation.