Realty Income Corp (O) 2015 Q3 法說會逐字稿

Ladies and gentlemen, welcome to the Realty Income 3Q 2015 earnings call. As a reminder, today's conference is being recorded. And at this time I would like to turn the conference over to Janeen Bedard. Please go ahead, ma'am.

Thank you all for joining us today for Realty Income's third-quarter 2015 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-Q. I will now turn the call over to our CEO, John Case.

Thanks, Janeen, and welcome to our call today. We're pleased with another solid quarter and our position as we move in to the end of the year and the beginning of 2016. Our AFFO per share annual growth during the quarter was 9.4% to a record quarterly amount of $0.70.

As announced in yesterday's press release, we are raising and tightening the range of our AFFO per share guidance for 2015 from $2.69 to $2.73 to the new range of $2.72 to $2.74, given the Company's strong year-to-date performance and the continued scalability of our business platform. A very high percentage of our revenue continues to flow to the bottom line.

We're also introducing our 2016 AFFO per share guidance of $2.85 to $2.90, representing annual per share growth of 4.4% to 6.2%. I'll now hand it over to Paul to provide additional detail on our financial results.

Thanks, John. As usual, I'll provide a few highlights of our financial statements for the quarter and begin with the income statement. Total revenue increased 9.8% for the quarter. 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 September 30 was approximately $992 million. Interest expense increased in the quarter to $64 million. This increase was due to the $250 million 12-year notes we issued in September of last year and the $250 million term loan issued at the end of last quarter, as well as lower amortization of mortgage premiums as our outstanding mortgage balance continues to decline.

We also did recognize a non-cash loss of approximately $5.2 million on interest rate swaps during the quarter. As a reminder, we entered in to an interest rate swap on the new term loan we issued in June which led to the larger non-cash loss this quarter. On a related note our coverage ratios both remain strong with interest coverage at 4.2 times and fixed charge coverage at 3.8 times. Both of these metrics are pro forma for the pay-down of the credit facility balance with proceeds from our common stock offering earlier this month.

General and administrative, or G&A, expenses were approximately $10.9 million for the quarter. Included in G&A expense this quarter is approximately $70,000 in acquisition costs and a reminder that we include these acquisition costs in our calculation of both FFO and AFFO. Year-to-date our G&A as a percentage of total rental and other revenues is only 5%. We estimate this 5% will remain our approximate run rate for G&A for the remainder of the year as efficiencies in our business model continue to drive improving EBITDA margins.

Property expenses which are not reimbursed by tenants totaled $3.4 million for the quarter. Year-to-date our property expenses as a percentage of total rental and other revenues is only 1.5%. We estimate this 1.5% will remain our approximate run rate for property expenses for the remainder of the year as these expenses have continued to come in lower this year with lower portfolio vacancy, faster re-leasing of vacant properties, lower property insurance premiums and fewer one-time maintenance expenses.

Provisions for impairment of approximately $3.9 million during the quarter included impairments on one property held for sale, one held for investment and two sold properties. Gain on sales were approximately $6.2 million in the quarter, and just a reminder, we do not include property sales gained in our FFO or AFFO. Adjusted funds from operations, or AFFO, or the actual cash we have available for distribution as dividends, was $0.70 per share for the quarter, a 9.4% increase versus a year ago. We again increased our cash monthly dividend this quarter and it now equates to a current annualized amount of $2.286 per share.

Briefly turning to the balance sheet, we've continued to maintain our conservative capital structure. In September we established an ATM, or at-the-market, equity distribution program to offer and sell up to 12 million shares, giving us the ability to issue equity capital on an opportunistic basis. Through quarter end we had not issued any equity through this program.

During the quarter we did raise $152 million of equity capital through our direct stock purchase plan. And earlier this month we raised $517 million in net proceeds in a common stock offering. We used the proceeds to pay down all outstanding borrowings on our $2 billion unsecured revolving credit facility.

Our bonds, which are all unsecured and fixed rate and continue to be rated Baa1, BBB+, have a weighted average maturity of 6.5 years. We again did not assume any mortgages during the quarter. We did pay off some at maturity so our outstanding net mortgage debt at quarter end decreased to approximately $695 million. Not including our credit facility, the only variable-rate debt exposure we have is on just $15.5 million of mortgage debt. And our overall debt maturity schedule remains in very good shape with only $2 million of mortgages and $150 million of bonds coming due for the balance of this year and our maturity schedule is well laddered thereafter.

Currently our debt to total market capitalization is approximately 28% and our preferred stock outstanding is only 2% of our capital structure. Our debt to EBITDA ratio after the equity offering is approximately 5.1 times. Now let me turn the call back over to John, who will give you more background on these results.

Thanks, Paul. I'll begin with an overview of the portfolio which continues to perform well. Occupancy based on the number of properties was 98.3%, a 10 basis points improvement from last quarter. At the end of the quarter we had 74 properties available for lease out of 4,473 properties in our portfolio.

Economic occupancy was 99.3% and occupancy based on square footage was 99%, increasing 10 basis points and 20 basis points, respectively, from last quarter. We continue to see an active leasing environment and expect our occupancy to remain around current levels through the end of the year. We had leases expire on 95 properties during the quarter and we re-leased 97 properties. Additionally, five vacant properties were sold during the quarter so our vacant property count decreased by seven properties relative to last quarter. 86 properties were re-leased to existing tenants and 11 were re-leased to new tenants. We recaptured 99% of expiring rents without any spending on tenant improvements, as is typical for us. We have a lot of experience in the theory of our business. Over the last 20 years we have re-leased or sold more than 2,000 properties with expired leases.

Our same-store rent increased 1.1% during the quarter and 1.3% year to date. We expect annual same-store rent growth to be approximately 1.3% this year and next year. As many of you know, the timing of our rent increases are irregular and will vary from quarter to quarter. 90% of our leases have contractual rent increases so we remain pleased with the growth we are able to achieve from our properties. Approximately 75% of our investment-grade leases have rental rate growth that averages about 1.3%.

Our portfolio continues to be diversified by tenant, industry, geography, and to a certain extent, property type. At the end of the third quarter, our properties were leased to 236 commercial tenants operating in 47 different industries located in 49 states and Puerto Rico. Our diversification contributes to the stability of our cash flow. 79% of our rental revenue is from our traditional retail properties. The largest component outside of retail is industrial properties at 13% of rental revenue. There was really not much movement in the composition of our top tenants and industries during the third quarter. Walgreens remains our largest tenant at 7% of rental revenue and drugstores remain our largest industry at 11% of rental revenue.

We continue to have excellent credit quality in the portfolio, with 44% of our rental revenue generated from investment grade tenants. This dropped from 48% last quarter due to the completion of Dollar Tree's acquisition of Family Dollar in July, which is now rated BB. This percentage will continue to fluctuate and will be positively impacted by two pending acquisitions of our non-investment-grade rated tenants by investment-grade rated tenants. Store level performance of our retail tenants remains sound. Our weighted average rent coverage ratio for the retail properties continues to be 2.6 times on a four-wall basis and the median is also 2.6 times.

Moving on to acquisitions, during the quarter we completed $124 million in acquisitions and we continue to see a high volume of sourced acquisition opportunities. Year to date we have sourced $24 billion in acquisition opportunities and we are on track for our second most active year ever for source volume. We remain disciplined in our investment strategy, acquiring less than 5% or $1.1 billion of the amount sourced year-to-date. A large portion of the acquisitions completed so far this year occurred earlier than we had originally expected which has had a positive impact on our 2015 earnings growth. We continue to expect approximately $1.25 billion in acquisitions volume for 2015.

Our initial guidance for 2016 acquisitions is approximately $750 million which principally reflects our typical flow business and does not account for any large-scale transitions. I'll hand it over to Sumit to discuss our acquisitions and dispositions. Sumit?

Thank you, John. During the third quarter of 2015 we invested $124 million in 47 properties located in 22 states at an average initial cash cap rate of 7% and with a weighted average lease term of 10.9 years. On revenue basis, 35% of total acquisitions are from investment-grade tenants. 52% of the revenues are generated from retail and 48% are from industrial. These assets leased to 18 different tenants in 13 different industries. Some of the most significant industries represented are transportation services, motor vehicle dealerships, and quick-service restaurants. We closed 10 independent transactions in the third quarter and the average investment per property was approximately $2.6 million.

Year to date 2015 we invested $1.1 billion in 195 properties located in 36 states at an average initial cash cap rate of 6.5% and with a weighted average lease term of 16.7 years. On revenue basis, 50% of total acquisitions are from investment-grade tenants. 87% of the revenues are generated from retail and 13% are from industrial. These assets are leased to 35 different tenants in 18 industries. Some of the most significant industries represented are health and fitness, drugstores, and quick-service restaurants. Of the 35 independent transactions closed year to date, 3 transactions were about $50 million.

The transaction flow continues to remain healthy, we sourced more than $4 billion in the third quarter. Year to date we've sourced more than $24 billion in potential transaction opportunities. Of these opportunities, 62% of the volume sourced were portfolios and 38% or approximately $9 billion were one-off assets. Investment grade opportunities represented 36% for the third quarter. Of the $124 million in acquisitions closed in the third quarter, 77% were one-off transactions. We continue to capitalize on our extensive industry relationships developed over our 46-year operating history.

As to pricing, cap rates remained flat in the third quarter, with investment grade properties trading from around 5% to high 6% cap rate range, and non-investment grade properties trading from high 5% to low 8% cap rate range.

Our disposition program remained active. During the quarter we sold eight properties for $21.5 million at a net cash cap rate of 7.2% and realized an unlevered IRR of 14.2% This brings us to 22 properties sold year-to-date for approximately $52 million at a net cash cap rate of 7.6% and realized an unlevered IRR of 13%. Our investment spreads relative to our weighted average cost of capital were healthy, averaging 212 basis points in the third quarter which were above our historical average spreads. We define investment spreads as initial cash yield less our nominal first-year weighted average cost of capital.

In conclusion, we remain confident of reaching our acquisition and disposition goals of approximately $1.25 billion and $65 million, respectively, for 2015. With that, I'd like to hand it back to John.

Thanks, Sumit. We've been active on the capital markets front during the year to meet our capital needs. Year to date we have raised approximately $1.2 billion in equity capital at an average per share price of approximately $48.50. This includes the $517 million equity offering earlier this month that Paul mentioned.

Our balance sheet is in excellent shape with plenty of liquidity and financial flexibility. Our sector-leading cost of capital continues to allow us to drive earnings growth while investing in high-quality assets. We increased the dividends paid this quarter by 4% on a year-over-year basis. We've increased our dividend every year since the Company's listing in 1994, growing the dividend at a compound average annual rate of just under 5%. Our AFFO payout ratio in the third quarter was 81.4% which is a level we are quite comfortable with.

To wrap it up, our portfolio is performing well and we are pleased with where we stand as we head in to the end of the year and in to 2016. We continue to realize the efficiencies associated with our size and the economies of scale of our net lease business. We believe our EBITDA margin is the highest in the sector at 93%. We continue to see a high volume of acquisition opportunities and our balance sheet is in outstanding condition with exceptional financial flexibility to fund future growth opportunities.

At this time we would like to open it up for questions. Operator?

(Operator instructions)

We'll go first to Juan Sanabria with Bank of America Merrill Lynch.

With your 2015 guidance, what factors are driving the still relatively large delta as we approach the end of the year and apply for the fourth quarter? I was wondering if you can give us a sense of what you expect dollar-wise for a percent in the fourth quarter.

The large delta with regard to FFO is a result of the swap and the impact that has on FFO. You don't see that, Juan, in AFFO. That's very difficult to predict a forward curve. You see it did have a $4 million impact this year. It could go up or down from there. But we wanted to make sure we left a range broad enough to handle what we thought would be reasonable in terms of movement there.

Then any color on percent rent for the fourth quarter? Any expectations you're thinking about?

Over the trailing 12 months we've received around $4 million in percentage rent. Our larger quarters are our first quarter typically. The fourth quarter won't have a large percentage rent. We're not expecting the fourth quarter to have a large percentage rent figure in it. But again, those are a bit irregular and we can be surprised, as we were in the second quarter with regard to percentage rents. Go ahead.

Just one more quick question on guidance. For 2016 the AFFO is actually higher than FFO. Is that related to swaps again? Because normally it's the inverse, at least if you look at 2015.

Yes, again, it is related to that. And Paul, do you want to elaborate on that?

Yes, one piece of that is the swaps and making some assumptions to account for potential non-cash gain or loss there. The other issue is less mortgage premium amortization, because our mortgage balance has gone down significantly, as you can see over time. And then the third piece would be a little bit less capital expenditure spend that we've projected for next year.

Great. A last more bigger picture question. With the Walgreens-Rite Aid merger, any thoughts on potential store closures, given overlaps that may be required as per the FTC and competition? And then do you expect the management team to maybe look at any real estate monetizations?

Let me take a crack at that one, Juan. Obviously, we view the merger as a net positive for the Company. We believe it's a credit and value enhancing event for Realty Income. It's likely to improve the credit quality, or definitely will improve the credit quality of the portfolio with an additional 1.8%, at least of our rent becoming investment-grade rated.

S&P affirmed the BBB rating yesterday but did put Walgreens on negative outlook which is normal in these M&A situations. As you recall, when we bought ARCT we were put on negative outlook while S&P waits to see you how execute and finance the transaction. There will be no impact on our revenue as a result of any possible divestitures. Walgreens will have the contractual obligation to pay the rent through the term.

The pundits in the market over the last two days have estimated that anywhere from zero to 400 stores could be closed, so that's quite a range. But on our Walgreens assets we have an average lease term of 13 years. On our Rite Aid assets we have an average lease term of nine years.

There's really little property overlap in the two portfolios. Of the 58 Rite Aid locations, we own 15 of those within a two-mile radius of a Walgreens store and the average lease term, I believe is about eight years. So we feel really good about that and we're pleased with both companies' performance. We'll take our -- depending on acquisitions between now and the end of next year, it will take our exposure, or our percentage of revenues from Walgreens, up to somewhere in the high 8%s probably, right around 9%.

But if we're going to have a tenant -- that's a little higher than we typically like the tenant concentrations to be, but if we're going to have a tenant there, we like that it's Walgreens. From a drugstore industry perspective, there will be no change and our exposure will still be at around 11%.

Okay. Thank you very much, John.

Okay, thanks, Juan, appreciate it.

We'll go next to Collin Mings with Raymond James and Associates.

Hi, good afternoon, guys.

Hi, how you doing, Colin?

First question for me, looks like that the industrial mix picked up a bit during the quarter, obviously, relatively low acquisition volume compared to the last few quarters. Can you talk a little bit more about that? It looked like the FedEx exposure ticked up a little bit.

Yes, as you know, the acquisitions compositions and amounts vary quite a bit from quarter to quarter. This quarter we had 52% retail and 48% industrial. And there lies the FedEx in there so we did take on some additional revenues from FedEx.

It's going to fluctuate. In the second quarter we had well in excess of $700 million in acquisitions and we've had quarters where they've been close to zero and quarters where they've exceeded $1 billion. It's certainly volatile, but there's really nothing to read into that.

When you look at what we've done year to date, 87% has been retail and we continue to have 79% of our revenues come from retail properties, so you're not going to see that number change much. So it's a bit of an aberration. It's just relevant here in the third quarter.

Okay. Then I guess, you touched on this in those remarks, but given the deceleration in the pipeline, again obviously, some lumpier, larger deals in the second quarter. You still feel pretty good about where your pipeline stands right now and not really any meaningful change in the composition of it? Is that fair?

That's very fair. We're going to have our third-best year ever in terms of completed acquisitions. We're going to have our second-best year ever in terms of sourced acquisition opportunities. So there's a lot of momentum in the business.

I wouldn't characterize this as declining momentum. I'd characterize this as typical fluctuations quarter to quarter in acquisition volume. So again, it's very difficult to predict. We're certainly comfortable with where the business is and with the momentum we have. Okay, and then as far as on the ATM, recognizing it is going to fluctuate depending upon where the stock price is, but what should we think about as how aggressive you might be looking to get with that in any given quarter? We would probably be at 1% or less of our equity market cap in a quarter. It's not something we're going to use to replace offerings with, but it allows us to match fund their acquisitions, be more opportunistic with regard to raising equity and to fund that equity at a much, much lower cost than we do a typical offering. We will continue to do offerings such as we did post third-quarter end.

Okay, that's helpful. Then one last one for me and I'll turn it over. Bigger picture, any changes to the watch list? Or anything else we should be aware of on that front? I know the last couple quarters you've referenced it being pretty stable. Just touch on that real quick.

Yes, it's pretty stable at 1.1% and not everything there we will end up selling. We are, as you've heard, looking at ramping up our dispositions a bit from what we had originally planned this year, from $50 million to $65 million.

We're achieving excellent results on our sales and these are our non-strategic properties. Some of them have issues associated with them, perhaps credit, real estate issues, coverage issues, industry issues. And some we're just selling because we have maybe some concentration issues and want to reduce our concentration levels.

The fact that we're able to sell these year to date at a 7.7% cap rate, 7.2% cap rate in third quarter and achieve an IRR unlevered of 14%, I think shows you the quality of our portfolio. Because we're culling off the lower-quality assets in general. So I hope that shows the market that we will get a strong portfolio, if that's where the properties we want to dispose of are trading.

Okay. On that point, as you referenced that cap rate, is it safe to say as you think about the 2016 guidance that you threw out there, that the dispositions that you look to complete in 2016 would likely be at a similar cap rate to what you've done here in 2015?

I would think so. We budget for something a little bit more conservative in the high 7%s, close to 8%. But again, it's going to be a function of the macroeconomic environment. I wish I were smart enough to be able to predict where interest rates in the macroeconomic environment will be next year. If there are no major changes, I think it's safe to assume we'll continue to execute at the levels we executed at this year.

Great, appreciate the detail.

Okay, thanks a lot.

We'll go next to Nick Joseph with Citigroup.

Thanks. The $750 million of acquisitions in 2016, what investment spread is assumed in guidance?

We're looking at cap rates that are probably right around what we're achieving now. So they're consistent with -- we're assuming there are no material changes in cap rate today. So assume those are in high 6%s area.

In terms of spreads, Paul, you want to hit on that in terms of constant capital? I think we'll continue to be in the area north of our long-term average of 150 or 140 basis points. We'll be in the upper 100s, maybe at the 175 basis points.

Thanks. Then just going back to the mix between retail and industrial, in terms of the acquisitions, do you expect a similar mix to this year?

Overall, yes, I think that's safe to say. Again, we see far more opportunities on the retail front and we're retail-oriented. 79%, as I said earlier, of our revenues are coming from our retail properties and we do not expect that to change materially next year.

And then finally, can you touch on the initial cash cap rate difference between what you've seen for retail acquisitions and industrial acquisitions this year?

Sumit, do you want to handle that?

Yes, sure. That's a very difficult question to answer because it definitely depends on the tenant, on the length of the lease, on what kind of a -- especially on the retail side -- on what kind of an asset it is. If you were to think of terms of an investment-grade tenant with a 15-, 20-year lease term with growth, they trade right around where -- in the same ZIP code. And it is very difficult to say that one asset class trades at the higher place.

Now when you obviously translate it on a price per square feet basis, et cetera, industrial we're looking at high-quality industrial assets right around that $70, $75 per square feet ZIP code. And retail once again, depending whether it's a Walgreens or whether it's a similar investment-grade rated, let's call it a Dollar General, they're going to have a different range anywhere between $175 to $225, $250.

Thanks. That's helpful.

Thank you.

We'll go next to Todd Stender with Wells Fargo.

Thanks. For Sumit, for the properties acquired in the quarter, can you give us the range what the lease terms were? The average was 10 years, so that's in line with your existing portfolio, but to look at anything on the shorter side?

Yes, I think we did have some in the high single-digits and a lot of them were bunched around that area from the high single-digits to around 13, 14. There were a couple assets that had north of a 15-year lease. That's part of the reason why we were able to get a slightly better yield.

Yes, you'll see sometimes in smaller portfolios we might have an average lease term, Todd, of 12 years. But you're going to have some that may be seven, eight years in there and certainly in larger portfolios as well.

We target 10 years and above, So typically initial lease terms range from 10 to 25. I think year to date they're just under 17 years which is a good number for us. We'd like to continue to focus on that as a long-term range and area to be in.

That's helpful. Was it just the one FedEx you acquired in the quarter?

Yes, that's correct.

Can you help us with pricing? As a comp, what the cap rate was, length of lease, and was this more of a FedEx ground facility?

It was a FedEx ground. We're not allowed to give any specific details on that transaction. We're subject to a confidentiality agreement with FedEx with regard to the specifics in pricing.

Okay, no problem. For Paul, when you look at your cost of equity, certainly you have the overnight markets open to you. You have the ATM in place, although you haven't tapped it. But the direct purchase plan, you've raised a fair amount of equity this year through that. Is there a low-cost, like an ATM-equivalent cost, to raising that amount of equity?

Yes, it's actually our cheapest form of raising equity, closer to a 1% average cost there of issuance, compared to an ATM which is going to be more like 1.5% to 2%. And then your overnight offerings are going to be more than that, obviously.

It is a product that will remain utilizing largely with existing shareholders as well as part of that, their ability to reinvest but not to any significant amount. As John mentioned, we'll be doing a little bit of that activity in-quarter going forward but any larger equity raises would be dependent upon acquisition volume.

Great, thanks. Lastly, when you look at the Rite Aid properties, if you were to assign a Walgreens cap rate to those going forward, do you guys look at it in terms of how much cap rate compression happened in one fell swoop?

Yes, if you look it at the market today, there's about a 50 to 75 basis points differential between where Rite Aid and where Walgreens would trade. You get a yield of anywhere depending on other factors, 50 to 75 basis points higher on a Rite Aid than you would a Walgreens. So we expect that to condense based on Walgreens acquisition.

Great, thanks, John.

Thank you, Todd.

We'll go next to Rich Moore with RBC Capital Markets.

Hello, guys, good morning or good afternoon. Did you pull back at all on your acquisition activity due to the softness that we saw in both the debt and equity markets in the third quarter?

No, we didn't. This was just a function of the opportunities we saw that met our investment parameters. There's a lot of, as I said, volatility from quarter to quarter in the amount and quality of acquisition opportunities we see.

We're very pleased with where our own balance sheet is. We've got a lot of financial flexibility and significant liquidity. So we did not specifically pull back on the acquisitions activity as a result of some of the volatility we saw in the marketplace.

Okay, great, thanks, John. I'm curious, Paul, on the bonds that you're doing or that you might do. Are these going to get bigger do you think? I think of you guys having $5 billion of debt roughly, that kind of thing, and 10-year laddered maturity. So I'm thinking of larger bond transactions when you do them. The last couple seemed smaller and I'm wondering are you going to carry more on your line of credit? Or are you going to do a bigger bond transaction going forward you think?

They may get bigger at times, of course. As we get larger as a Company, you could certainly see larger issuances. Certainly the minimum of $250 million to be index-eligible is something we would always pursue.

But at points in time when you go to issue the bond it really depends on what your needs are at that particular time. If you don't have, say, a $500 million cash need at that moment, you're not going to issue $500 million bonds. That's happened a few times.

Furthermore, we haven't quite seen any pricing improvement having a larger offering size. If we would start to understand that you'd get a little bit better pricing from the debt investors for a larger liquid offering, that's something we may even pursue more.

It's been an interesting conversation we've had and certainly something we've studied, Rich. And that is, do you get paid for larger more liquid offerings? And certainly a lot of our income investors would prefer those and say that you do. But when you look at the case studies available and we work with our bankers, you don't see a pricing advantage.

But that being said, a larger company, as Paul said, larger transactions, I think you'll see our average transactions certainly grow beyond $250 million. And you could see some $0.5 billion bond deals in our future.

Okay, is there a negative to going to market too often? Like if you had to do $1 billion and you did four, one each quarter of $250 million, is that a negative?

If that was the scenario, for example, I think the preference would be to do, say, two $500 million rather than four $250 million, as your fixed-income investors would prefer the larger liquidity in each particular issuance. But you can't always predict what your needs are going to be, the state of the bond market, the acquisition deal flow timing, that sort of thing, of course.

Good, I got you. Then I wanted to ask you guys, too, about development if I could. I'm trying to figure out exactly, when I look at the supplemental, exactly what's happening with development.

If I was on page 13, you have investment in 18 development properties in the quarter. Then when you look on page 15, you have 11 properties currently underway. So I'm assuming seven were delivered in the quarter? Is that correct?

That's correct.

Okay, and then as you look forward, that remaining investment on page 15, the $58 million, how should we think about the timeframe over which that's going to occur? On top of that, how many more we might add on a quarterly basis, new properties to the list.

As of right now, as it says on page 15, we've got $58 million of additional commitments to spend. Based on the pipeline, the next quarter we don't expect to add any new additional developments so that number should remain pretty static. Of course we're going to expand off of that 58 so you'd expect that to go down. In the event we do hear back from some tenants, et cetera, with regards to redevelopment, et cetera, that's the only reason why that $58 million will change.

So I should pro rata that $58 million over the next year? Or I guess it's through January, so I guess through the next quarter or so.

At the run rate today, yes.

All right, great, thanks, guys.

Thanks, Rich.

We'll go next to Dan Donlan with Ladenburg Thalmann.

Thank you and good afternoon.

Hi, Dan.

Hi. I was wondering if you guys could touch a little bit on the operating expenses and why that continues to come in below your expectations. Your recovery ratio seems to be fairly high relative to what it has been historically.

With regard to -- are you talking about with regard to G&A or property or both?

Frankly both, but just on the property operating expenses, 1.5%, that's a lot lower than what it has been historically.

Really, we've realized probably $4 million to $5 million in savings due to fewer defaults this year and lower vacancy. I think it improved stronger portfolio, it's reducing our property expense obligations that the Company is responsible for. We're also -- helping drive that is much quicker resolution of lease roll-overs. We've improved our property insurance premiums as well as we become a larger Company with scale.

On the G&A front, if you go back and look at our headcount, about three years ago we had some pretty significant additions in head count. The year after that they were fairly significant. We were really positioning the Company to handle the growth that we had anticipated and we had hoped would continue. Those hirings have fallen each year.

We've put really skillful people in place, I think, and having more efficient organizational structure and more efficient systems, which allow us to have better G&A margins. So there's some other items related to that. But that's what it's really about.

When we budgeted this year we budgeted for some headcount that we did not end up having to add to the Company, which helped us come in at $2 million to $4 million below where we thought we were going to be on that item. So that's what really is driving both property expenses and G&A expense margins.

Okay, so you're not handing out jelly of the month club, end-of-year bonuses or anything like that, I guess.

(Laughter) That's right.

So just curious, Paul, on the leverage. At 5.1 times on net debt to EBITDA, looking at my numbers, it seems to be the lowest you've been in quite some time. Is there any type of concerted effort on your part, or on the Company's part, to maintain a lower level leverage than you have over the last couple of years? Or is it simply a function of timing?

It's really a function of timing. We remain -- I'm not Paul, obviously, but I want to talk about this philosophy. We're comfortable with the Company at two-thirds equity, one-third debt. Right now we're closer to 70%, 71% equity today, a little more conservatively capitalized than that.

We saw an attractive opportunity to execute an overnight offering at pricing that would be attractive and highly accretive to our investments and we've had a use for the proceeds. And we've wanted the position the balance sheet in a manner where it was very clean and liquid and ready to fund our anticipated acquisitions going in to 2016.

So this is not a new level that really represents a change in leverage policy for us, Dan. It's just a result of the recent large equity offering.

Okay, understood. Is there any type of -- is there any seasonality to 2016's acquisitions? Do you think they'll be more front-end loaded or more back-end loaded or ratably over the year?

I wish we could answer that question. This year we thought they were going to be more back-end loaded, given a couple of larger portfolios we were working on and hearing when those tenants wanted to close. And then two changed and all of the sudden we went from expecting a back-end loaded acquisitions year that switched to a front-end loaded acquisitions year.

It's really difficult to predict. So in our model right now we just have that $750 million based on a pro rata structure throughout the year. It won't happen that way. There will be quarters where there's big numbers and there will be quarters where there are small numbers. Unfortunately, I'm not smart enough to tell you which quarters are going to be big and which quarters are going to be small. (laughter)

Okay, fair enough. Then from a portfolio standpoint, has the private letter ruling that's gone away, the IRS or FCC or whoever it is, has said they're going to stay away from this stuff, this op-gov, prop-co type of structure that people have done. Have you seen any increase in inbound calls to you guys because of this change in policy from the government?

We continue to be involved in a number of conversations on that front. We did interpret that as a net positive. Because if you are going to monetize real estate, the IRS has taken that stance. Then sale leaseback transactions with companies like ours is the appropriate and best execution we believe.

Has there been a sea wave of additional discussions? No, but there's been a slight uptick. We continue to be fairly optimistic that one or two of those will hit and be significant.

Okay, thank you very much, appreciate it.

Okay, thank you.

We'll go next to Chris Lucas with Capital One Securities.

Good afternoon, guys. John, following up on a couple of the last questions, on the philosophy side, I guess I was wondering if you might be able to remind us what your thoughts are in terms of max category exposure that you would be willing to take and max single tenant exposure that you guys would take.

Sure, Chris. What we've said on single tenants is that we're comfortable in the mid single-digit range. So call that to 7%. Under certain circumstances we would be comfortable going above that, but over the long run we'd like to manage that exposure back down because the diversification is highly important to us and our strategy.

So you'll see that we -- assuming that the Walgreens-Rite Aid transaction closes, we'll have a tenant that's in the upper 8%s in terms of percentage of revenue. That will be a tenant we look very, very closely at in terms of increasing our exposure. In fact, we would not want to increase that exposure unless there was just something exceptional in terms of an incredibly attractive investment opportunity. And then we'd have discussions with our team here and with our Board to see if we even wanted to do that.

On the industry side it's always been in the lower double-digits, in the 10% to 12% range and we want to remain in that area. Right now we're in that area. But the diversification is something that we think is important in our type of business.

Okay, and then you talked a little bit before about the spread differential between the Walgreens and the Rite Aid leases. Other than credit and obviously, lease term length, but are there lease items that are also included in that price differential?

When you say lease items --? (multiple speakers)

Go ahead, sorry.

There's more growth in the Rite Aid leases than there is on the Walgreens leases. So I don't know if that's what you were asking about or not, but there are some minor differences in terms of the two types of leases but not major.

Okay. Then going back to Dan's question about the private letter ruling arena, have you guys looked at the infrastructure business at all as an opportunity that Realty Income might look at?

We see so many opportunities and the investments that fall within our investment parameters today, that that's not something we're really looking at. We do have a group and a team here that we're constantly looking at what other alternatives in terms of properties may make sense for us to pursue. But we're really comfortable with where we are right now and certainly don't have any plans to go into the infrastructure business.

Okay, and then last question, probably for Paul. On the EBITDA or coverage ratio, can you give us a sense of what percentage revenue is actually included in that calc?

What percentage of revenue is actually included?

I'm assuming it's not 100% of the revenue that you're collecting, right? It's some proportion of the tenants that report that information to you?

Oh, oh, I'm sorry, yes. I thought you were talking about our debt-to-EBITDA ratio for some reason.

No, no I'm sorry.

We get that information from the majority of our retailers.

It's just under 70%.

70%, yes. And so that's what that's coming from. It's not 100% and it's around 70%.

Great, thank you, guys.

Thank you.

Ladies and gentlemen, that does conclude the question-and-answer portion of Realty Income's conference call. I would now like to turn the call back over to John Case for concluding remarks.

Thanks, Aaron. We appreciate everyone joining today and look forward to seeing most of you in a few weeks at NAREIT. Have a good afternoon and thanks again. Take care.

This does conclude today's conference, everyone. We thank you for your participation. You may now disconnect.