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Realty Income Corporation (NYSE:O)

Q2 2014 Results Earnings Conference Call

July 24, 2014, 04:30 PM ET

Executives

Janeen Bedard - Associate Vice President

John Case - CEO

Paul Meurer - CFO

Sumit Roy - EVP and Chief Investment Officer

Analysts

Jonathan Pong - Robert W. Baird

Vikram Malhotra - Morgan Stanley

Todd Stender - Wells Fargo

Cedrik Lachance - Green Street Advisors

Dan Donlan - Ladenburg Thalmann

Ross Nussbaum – UBS

Todd Lukasik - Morningstar

Operator

Good day and welcome to the Realty Income Second Quarter 2014 Operating Results Conference Call. Please note today’s conference is being recorded.

At this time, I would like to turn the conference over to Ms. Janeen Bedard, Associate Vice President. Please go ahead, ma’am.

Janeen Bedard

Thank you, Joshua, and thank you all for joining us today for Realty Income’s Second Quarter 2014 Operating Results Conference Call.

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

During this 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.

John Case

Thanks, Janeen, and good afternoon, everyone, and welcome to our call. We had another solid quarter of operating results with AFFO per share increasing 8.5% to $0.64, and we are pleased with the continued consistency of our business. I will start with Paul providing you an overview of our financial results.

Paul?

Paul Meurer

Thanks John. So, as usual, I will comment on the financial statements to provide a few highlights of our financial results for the quarter, starting with the income statement. Total revenue increased 22.6% for the quarter, and this increase obviously reflects our growth from new acquisitions over the past year as well as some healthy same-store rental growth in the portfolio.

Our annualized rental revenue now as of and at June 30 annualized was approximately $897 million.

On expense side, depreciation and amortization expense increased to almost $93 million in the quarter as depreciation expense has obviously increased with our portfolio growth.

Interest expense increased in the quarter to $52.7 million. This increase was primarily due to the $750 million issuance of 10-year bonds last July, as well as higher mortgage interest and credit facility borrowings during this past current quarter. On a related note, our coverage ratios did both remained strong with interest coverage at 3.7 times and fixed charge coverage at 3.1 times.

General and administrative or G&A expenses in the quarter were approximately $11.6 million. Our G&A as a percentage total rental and other revenues has decreased to only 5.2% of revenues and our projection for G&A for 2014 remains at approximately $50 million.

Property expenses were $10.1 million in the quarter. However, just a reminder this amount includes $6.2 million of property expenses reimbursed by tenants that you can see up in the revenue line. The property expenses that we are responsible for were approximately $3.9 million in the quarter. And our projection for 2014 of property expenses that we are responsible for remains approximately $16.5 million.

Income taxes consists of income taxes paid to various states by the company and they were $570,000 for the quarter. Provisions for impairment includes just under $500,000 of impairments we recorded on two properties held for sale at June 30th. Gain on sales of approximately $2 million includes the gains from the sale of six properties during the quarter for gross proceeds of $7 million.

Discontinued operations only refers to properties that were already held for sale as of year-end 2013. So reminder that last quarter we elected early adoption of the new accounting regulations for property sales.

So all of our property sales, gains, impairments and other related revenues and expenses associated with properties that are for sale or held of sale, now appears through the income statement as opposed to being aggregated in the discontinued operations line. And again, the exception to that is one property was already held for sale as of yearend 2013.

Deferred stock cash dividend totaled approximately $10.5 million for the quarter. Net income available to common stockholders was approximately $51.4 million for the quarter. Funds from operations or FFO per share was $0.64, a 6.7% increase versus a year ago.

Adjusted funds from operations or AFFO or the actual cash we have available for distribution and dividends was $0.64 per share for the quarter or 8.5% increase versus a year ago. We again, increased our cash monthly dividend this quarter and our monthly divided now equates to current annualized amount of approximately $2.194 per share.

Briefly, turning to the balance sheet, we have continued to maintain a very conservative and safe capital structure. As you know in early April we raised $529 million of new capital with a common equity offering.

We also raised $52 million of additional common equity through our direct stock purchase plan during the quarter. And in late June we've raised %350 million with a 10-year bond offering priced at 3.88% yield.

Proceeds from all of these offerings were used to repay borrowings on our $1.5 billion acquisition credit facility, which had a balance at June 30th of $70.8 million. We did assume approximately $114 million of in place mortgages during the second quarter. So, our outstanding net mortgage debt at quarter end increased to approximately $892 million.

Our bonds which are all unsecured and fixed rate and continue to be rated Baa1, BBB+ have a weighted average maturity of 7.4 years. Our overall debt maturities schedule is in good shape, with only $57 million of mortgage principle payments during the second half of 2014 and $125 million in 2015. And our next bond maturity is only $150 million due in November of 2015.

Our debt-to-EBITDA at quarter end was only 5.5 times. Currently, our total debt to total market cap is approximately 30% and our preferred stock outstanding is only 4% of our capital structure.

So, in summary, our earnings growth is very positive, while our balance sheet remained very healthy and safe.

Now, let me turn the call back over to John who will continue to give you background on these results.

John Case

Thanks Paul. I’ll begin with an overview of the portfolio which continues to be quite healthy. Our tenants are continuing to doing well based on what we're seeing today. Occupancy remains consistent with the previous quarter at 98.3% based on the number of properties with 74 properties available for lease out of 4,263 properties.

Occupancy is up 10 basis points from one year ago. Occupancy based on square footage is 99%, economic occupancy is 99.1%. During the quarter, we had leases expire on 40 properties.

Of these assets, we released 33 to existing tenants, 4 to new tenants, and sold two with one remaining vacant at the end of the quarter. We increased the rental revenue on these released properties by 3% with the second quarter leasing activity. We expect our occupancy to remain fairly stable for the remainder of the year.

Our portfolio remains diversified by tenant, industry, geography and to a certain extent property type. At the end of the second quarter, our properties were leased to 228 commercial tenants and 47 different industries located in 49 states and Puerto Rico, 78% of our rental revenues from our traditional retail properties, while 22% is from non-retail properties. The largest component being industrial and distribution.

We believe our diversification leads to more predictable and dependable cash flow streams to our shareholders. Moving on to the tenant base, at the end of the second quarter, our 15 largest tenants accounted for 45.8% of rental revenue and our largest 20 tenants accounted for 52.3% of rental revenue. Beginning this quarter, we will start disclosing our top 20 tenants. The next 5 tenants being our 15 largest, account for 6.5% of rental revenue.

We believe the additional disclosure will provide investors more insight on our material tenants without jeopardizing our competitive position in the sector. The tenants in our top 20 capture nearly every tenant representing more than 1% of our rental revenue.

The new disclosure is part of a broader effort we are starting this quarter to provide additional disclosure beyond what we have previously provide to give our analysts and investors even better insight into our business.

We’ve listened to our market constituents and designed a supplemental investor package to provide more information on our company’s operations and put previously disclosed information in the K and in our Qs in a more easily accessible format by also incorporating it into the supplement.

So with the following our 10-Q this afternoon we will be furnishing an 8-K with a supplemental investor package that will also be available on our website.

We want to lead the way in the net lease sector to providing greater transparency for our investors. We hope that this will enable our shareholders and perspective shareholders to more efficiently evaluate our operations and we look forward to discussing our new supplement with you in the ensuing months.

There have been no material changes to our top 15 or top 20 tenants since the first quarter. We’ve made significant strides over the last five years and diversifying our tenant base and our rental revenues. Today our top 20 accounts were 52% of our rental revenue versus 62% and the beginning of 2010. The percentages moved down while the composition of tenants from a performance and credit perspective has markedly improved. Today, eight of our top 20 tenants have investment grade credit ratings and at the beginning of 2010 none of our top 20 tenants had investment grade ratings.

The non-investment grade tenants in our top 20, which are all retail, are were also higher quality more substantive businesses than the non-investment grade tenants we had in our top 20 in 2010. Today the non- investment grade retail tenants in top 20 have averaged annual revenues of about $5.5 billion versus just over $3 billion in 2010.

Our top 20 tenants today include the top three drug store chains, the top two dollar store chains, the top two movie theatre chains, two of the top three wholesale clubs, the second largest independent tire dealer, the largest quick service restaurant franchise, the number one fitness club operator in the U.S., FedEx and [DRGO] (ph) two global Fortune 300 companies that are clear leaders in their industries and our convenient store tenants that are dominant operators in their respective regions.

And as we've improved the quality of our top 20 tenants, we've also improved the quality of our real estate locations. Within our portfolio no single tenant accounts for more than 5.2% of rental revenues, so diversification by tenant remains favorable.

Walgreens continues to be our largest tenant at 5.2% of rental revenue which is down slightly from last quarter. FedEx remains our second largest tenant at 5% which is also down slightly from last quarter.

Dollar General is our third largest tenant today at just under 5%, LA Fitness and Family Dollar were at 4.6% and 4.5% respectively. All other tenants throughout of the world were 2.9% of rental revenues.

When you go to the 15th largest tenant which remains Walmart/Sam's Club, it represents 1.5% of rental revenue. If you move in other five spots and go to our 20th largest tenant which is Camping World, it represents only 1.2% of rental revenue.

Moving to our 35th largest tenant, it accounts for just 0.5% of rental revenue, and the percentages trail off from there. We also increased the number of tenants on our portfolio this quarter by 17, further diversifying our tenant base.

Moving on to industry, convenient stores remain our largest industry but continue to decline as a percentage of our rental revenue. Convenient stores now represent 10.2% of rental revenue. Dollar stores are now at 9.8%, up from 9.1% last quarter.

With lower and middle consumers remaining under pressure, we continue to like the discount orientation of the dollar store industry. And Dollar General and Family Dollar remain the dominant players in this industry. Drugstores are at 9.5%. Health and fitness is at 7%, and all other industry categories are at or below 5.2% of rental revenue.

Looking at property type, retail continues to represent our primary source of rental revenue, currently at 78%, with industrial and distribution at 11%, office at 7% and the remainder evenly divided between light manufacturing and agriculture.

We continue to focus on retail tenants that meet our investment parameters. More than 90% of our retail portfolio continues to have a service, non-discretionary or low price point component to their business.

These characteristics better position our tenants to successfully operate in all economic environments and make them less vulnerable to internet competition. Our weighted average remaining lease term continues to be a little less than 11 years, at 10.6 years.

Our same-store rents increased 1.4% during the quarter and year-to-date generally consistent with our long-term average. The industry is contributing most to our quarterly same-store rent growth for convenient stores, automotive tire service and health and fitness. We expect our growth rate to continue to be in the 1.4% to 1.5% range.

The tenant credit quality of the portfolio continues to be strong with 44% of our rental revenue generated from investment grade tenants. Again, we define an investment grade rated company that’s having an investment grade rating by one or more of the three major rating agencies. This revenue percentage is also up from 38% one year ago

We continued to generate solid rental growth from these investment grade tenants. 70% of our investment grade leases have rental rate increases in them. Overall, annual rental growth from investment grade tenants is 1%.

In addition to tenant credit, the store level performance of our retail tenants remains positive. Our rent coverage ratio or EBITDA to rent ratio on our retail properties is approximately 2.6 times.

Moving on to property acquisitions. As you know, we had an active second quarter, continuing our momentum from the beginning of the year. We continue to capitalize on our extensive industry relationship developed over our 45-year operating history to generate quality acquisition opportunities.

We completed 405 million in acquisitions during the quarter at an initial yield of 7.3%. Today's investment spreads are well above our historical average. As a reminder our initial yields are cash yields and not GAAP cap rates which tend to be higher due to straight-lining the rent.

We define cash cap rates as contractual cash net operating income for the first 12 months of each lease following the acquisition the date, divided by the total cost of the property including all expenses borne by reality income including third-party reports, transfer taxes and brokerage fees.

Included in these acquisitions is the remaining $229 million of the $503 million transaction within when diversified. That is now fully closed. Year-to-date this brings us to $1.06 billion in completed acquisition. This is a record amount of property level acquisitions for the first half of any year in the company’s history.

Given our very active first six months of the year, we are raising our acquisitions guidance for 2014 from $1.2 billion to approximately $1.4 billion. We will continue to remain selective and disciplined in our acquisition activity.

Now, I would like to hand it over to Sumit to provide additional details on our acquisitions.

Sumit Roy

Thank you, John. During the second quarter of 2014, we invested $405.1 million in 73 properties located in 27 states at an average initial cash cap rate of 7.3% and with a weighted average lease term of 10.6 years.

Out of the total amount approximately 40% or $157 million was invested in non-investment grade retail properties. On a revenue basis, 55% of total acquisitions are from investment grade tenants. 76% of the revenues are generated from retail, 9% are from industrial, distribution and manufacturing, and 15% are from office.

All of the office assets are part of the previously announced inland transaction. These assets are leased to 33 different tenants in 22 industries. Some of the more significant industries represented are home improvement and diversified industrial.

Year-to-date 2014, we've invested $1.06 billion in 402 properties located in 39 states at an average initial cash cap rate of 7.1% and with the warhead average lease term of 12.8 years. Out of the total amount, approximately a quarter or 243 million was invested in non-investment grade retail properties.

Since 2010, we have invested over 2 billion in non-investment grade retail properties, which is the most active period in the company's history for acquisitions of this property segment.

On a revenue basis, 73% of total acquisitions are from investment-grade tenant. 83% of the revenues are generated from retail, 9% are from industry distribution, and manufacturing, and 8% are from offices. These assets are leased to 45 different tenants in 24 industries. Some of the more significant industries represented are dollar stores, drug stores, and home improvement.

Transaction flow remains healthy. We sourced more than 6 billion in the second quarter of 2014. Year-to-date we have sourced more than 14 billion in potential transaction opportunity, which put us in pace to make 2014, the year with the second largest volume sourced in our company's history.

Of these opportunities, 79% of the volumes sourced were portfolios and 21% or $3 billion were one-off assets. Investment grade opportunities typically represent 30% to 45% of the volume source.

We came in at 37% for the second quarter in line with our long-term average. Off the $405.1 million acquisitions closed in the second quarter, approximately 20% were one-off transactions, 88% of the transactions closed in the second quarter were relationship driven.

We continue to utilize our relationships and look for the best real estate opportunities, regardless of tenants credit ratings in a one-off or a portfolio transaction to help us achieve the optimal risk adjusted returns. We do this by remaining very selective and disciplined in our investment approach.

As to pricing, cap rates tightened 15 to 20 basis points in the second quarter, with investment grade properties trading from high 5% to high 6% cap rate range and non-investment grade properties trading from high 6% to low 8% cap rate range.

Our investment spreads relative to our weighted average cost of capital were very healthy averaging 215 basis points in the second quarter and a 185 basis points year-to-date, which was significantly above our historical average spreads.

We defined investment spread as initial cash yield less our nominal first year weighted average cost of capital. We are continuing to make investments above our historic spreads, whilst improving our real estate portfolio, tenant quality, credit quality and overall diversification.

In conclusion, the second quarter investments remained healthy at 405 million. Year-to-date we have invested 1.06 billion while sourcing over 14 billion in transactions. Although cap rate compression was evident in the second quarter our cost of capital continue to improve and as a result, our spreads remained comfortably above historical level.

Also, even though our sourcing volumes remained robust for both, retail and non-retail assets, the investment grade and non-investment grade tenants and single asset and portfolio deals, we continue to be very selective in pursuing opportunities that are inline with our strategic objectives and within our acquisition parameters. We remained confident of reaching our updated investment goal of approximately 1.4 billion for 2014.

With that I would like to hand it back to John. Thank you.

John Case

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

During the quarter we sold six properties for $7 million at an unlevered internal rate of return of approximately 9%. This brings us to 17 properties sold during the year for 20 million at an unlevered IRR of approximately 10% and a cap rate of 8.4% on the least property sold. Disposition activity should ramp up during the second half of the years, so we continue to anticipate dispositions for 2014 to be approximately 75 million.

Moving on to our capital raising activities, as Paul mentioned, we were quite active during the quarter raising just under 1 billion in permanent and long-term capital. Approximately two-thirds of this capital was equity and one-third was 10 year unsecured debt.

The capital was used to find acquisitions and to reduce the outstanding balance on the credit facility. We now have over $1.4 billion available on our law and to support future acquisitions activity and our balance sheet continues to be in great shape.

We continue to enjoy excellent access to attractively priced permanent and long-term capital.

We continue to see healthy per share earnings growth, while maintaining a leveraged neutral balance sheet. Our FFO and AFFO per share of $0.64 in the second quarter represented increases of 6.7% and 8.5% respectively from a year ago. Given our robust level of acquisitions during the first half of the year and increased visibility on our operations, we are adjusting our FFO and AFFO for share guidance from our initial estimates of $2.53 to $2.58 per share.

We are raising our 2014 FFO per share guidance to $2.59 to $2.62 which represents an 8.1% increase at the mid-point of the range over our 2013 FFO. And we are tightening and raising the mid-point of our AFFO per share guidance to $2.55 to $2.57, which represents a 6.2% increase at the mid-point of the range over our 2013 AFFO.

Our earnings growth continues to support reliable and growing monthly dividend. We reached the company milestone in June surpassing $3 billion in dividends paid to our shareholders over the company’s 45 year history.

We’ve increased the dividend every since the company’s listing in 1994 and our dividend has grown at a compounded average annual growth rate of approximately 5% during that time. We are proud of our long history of consistent dividend growth.

Our payout ratio during the second quarter was 85.5% of our AFFO which is at a level we continue to be comfortable with.

Again, we are pleased with our company's operating performance for the first half of the year. And looking forward, we continue to see an active, but competitive acquisitions market. We are confident we will continue to execute attractive acquisitions that are consistent with our investment strategy.

While cap rates remain under pressure, we continue to see investments spread and its well above our historical average given a favorable cost of capital.

With that, I would like to open it up for questions. Joshua?

Question-and-Answer Session

Operator

Thank you so much, sir. (Operator Instructions) We will take our first question from Jonathan Pong with Robert W. Baird.

Jonathan Pong - Robert W. Baird

Hi, good afternoon guys. John, just a quick question on the EBITDA rent coverage ratio you mentioned, is that a four wall number or does that includes some kind of corporate allocation?

John Case

That’s a four wall number and pre G&A.

Paul Meurer

Most recent quarter annualized.

Jonathan Pong - Robert W. Baird

Got it. And do you guys have number with [DA] (ph) that include sort of allocation?

John Case

No.

Paul Meurer

Wait, which number you are asking about, you are taking about debt to EBITDA or you are talking about the cash flow coverage?

Jonathan Pong - Robert W. Baird

The EBITDA rent coverage, [2.6] (ph) I believe?

Paul Meurer

Sorry, that is a four wall for the retail properties in the portfolio. And that does include some allocation for corporate G&A expense in that calculation as part of our underwriting.

Jonathan Pong - Robert W. Baird

Okay. Great. And then going back to the assets sales it does seems to be a little slower phase so far this year. Is that really a function of your watch list doing the link down? And then if so, have you guys considered refreshing of the criteria for those assets like [Minnesota] (ph) to take advantage to supply appetite out there right now.

Paul Meurer

Yeah. So really it's a function of the assets sales being a bit unpredictable. We knew a number of them we're going to be backend loaded this year. So we still anticipate, $75 million and when we look at our watch list right at properties combined with tenant credit.

It represents about 1.5% of our overall rental revenue. And those are – those are properties we're considering selling, but not all of which we will sell. There are just once we are watching closely either based on credit issue or perhaps property location issue Jonathan.

Jonathan Pong - Robert W. Baird

Okay. So that 75 million, do you see that trending down significantly as we head into 2015?

Paul Meurer

It could it's all going to be function what goes on or off of the watch list and as that evolves, that's blew it and something we look at constantly. So we if it were to decline we would see less property sales activity and if it were to increase we would probably see more property sales activity.

Jonathan Pong - Robert W. Baird

Great. And then, lastly question just sort of on your cost of capital as I think about that. Given how low it is right now where your spreads are. At the margin, does that compel you guys to pursue more of the investment grade maybe sub 7 cap rate deals while still preserving that spread, or does that make you think about just maximizing that spread and continuing to acquire more of a blend?

John Case

Yes, what we are doing from an acquisition standpoint is pursuing both non-investment grade and investment grade properties that’s meet our investment parameters and offers the best returns on a risk-adjusted basis.

So that’s the factored our cost of capital is low right now. It’s not driving us to try to do more higher yielding assets or lower yielding assets. We are just looking at the best opportunity based on our investment strategy and the risk adjusted return offered by both non-investment grade and investment grade opportunities.

Jonathan Pong - Robert W. Baird

All right. That’s helpful. Thanks, guys.

John Case

Thanks, Jonathan.

Operator

And we’ll take our next question from Vikram Malhotra with Morgan Stanley.

Vikram Malhotra - Morgan Stanley

Hi, guys. Thanks for providing the additional information and the release and then look forward to going through the supplements. Just wanted to clarify the 5 million or the $5.2 million increase on the leases or lease is signed – be signed were most of that – was most of that retail, or was there decent some office or industrial component to it?

Paul Meurer

Yes, it was virtually all retail. I think it was 99%, maybe even 99.9% retail.

Vikram Malhotra - Morgan Stanley

Okay, just wanted to clarify. And then Sumit just on the acquisition I noticed the remaining lease term kind of was a little lower than what you typically done in 2012, 2013 and probably the first quarter of this year, was there kind of any bunch of assets that kind of drove that remaining lease termed down towards 2010 from 2014?

Sumit Roy

When we are buying assets across the spectrum where its portfolio deals, etcetera, you’ll find assets that tend to be in the low double-digit area in 2010 and in some cases even high single-digit area. So when you blend it out it came out to be 10.6, but this is not to be viewed as this is what we are doing in order to get higher spreads.

If you look at what we did in 2011 in fact in the third quarter average lease term there was in the high single-digits and if you look at year-to-date what our average is been, it’s been about 12.8 a year. And so and that's where we expected to end up by the end of the year. So I won't read anything into it more so than that's where it ended up for the second quarter.

Vikram Malhotra - Morgan Stanley

Okay. And then just last one, I mean, you talked about declining cap rates, again 2Q given where your cost of capital less than and you obviously updated the acquisition guidance, but what would make you say I want to be even more selective in that sense would not really going forward kind of take that $1.4 billion even higher. So what would make you get even more selective?

Sumit Roy

If you see what we’ve done, I mean, we’ve done a $1 billion, a 1.06 billion and we’ve increased it by 350 million, despite seeing very healthy sourcing volumes. That in itself should be an indication to you as to are selectiveness.

Look, I mean, given our cost of capital advantages today, we could be pursuing a much higher volume if we chose to do so and making very reasonable spreads. But what we are starting to see is a mispricing of assets where we don't feel compelled despite the fact that we could create value for our shareholders in pursuing those opportunities.

So I think we are going to remain very, very selective and that's indicated by John in terms of what our guidance is for the year.

Paul Meurer

Yeah. So we actually executed 7% of what we executed and close 7% of what we've sourced. If we were to relax our investment parameters and standards we could crank our volume up of closed transactions quite a bit, but the intent is not to do that soon.

So we will remain selective. And as we sit here today it looks like that approximately $1.4 billion in total for the year looks like a pretty good number for us.

Vikram Malhotra - Morgan Stanley

And just lastly on just to clarify on the competition that you mentioned, are you seeing a different composition in terms of the competition? And you kind of alluded to the fact that there's probably a lot of aggressive bidding which is why you're being a little selective, but is that type of competition changing in any way?

John Case

No. It really hasn't -- it's a mix of the other public net lease REITs, the non listed net lease REITs. We do bump into some of the mortgage REITs; we do bump into some institutional investment managers that are running income-oriented money in the net lease sector that was probably once year-marked for the bond sector. So it's generally the same cast of characters, but they are well capitalized and there is a contingent to be a bit more capital out there.

Vikram Malhotra - Morgan Stanley

Okay. Thanks. Thanks guy and thanks again for the additional info.

John Case

Okay. Thanks Vikram.

Operator

And we'll move next to Todd Stender with Wells Fargo.

Todd Stender - Wells Fargo

Hi, guys. Just a echo of the previous comment, that you are really seeing discloser was really helpful. Are these about the right percentages to assume for the remainder of the year, just when you think about releasing and you know ultimately with your success in doing this, does this give you any appetite for short or medium-term leases, may with tenants you already have a deep relationship with, just kind of seeing, what the opportunities are for some higher yielding opportunities if you have expertise in this?

John Case

Yeah. Let me first had -- in terms of, you know where are our roll, you know roll up was in rents this past quarter. You know we were able to increase some 3% on our releasing activity. Over the life of the company we have been able to preserve about 95%, 96% of the expiring rents.

So as we look forward you know over recent years we've been doing better than our long-term average. So we would expect to be north of our long-term average and we would hope we would be able to continue you know at around a 100% or north of that.

Todd Stender - Wells Fargo

And then just part two to that is that create any opportunities for you guys to look at opportunities outside of you know 10, 12, 15 year leases and look at stuff maybe with five to seven years left, that may become a little higher risk but also higher yield, but that you probably can renew?

John Case

You know we emphasize longer term leases, there are situations Todd where when we go out with a lease term like we did average lease term of 10.6 years like we did this quarter, we are buying some assets that have shorter lease terms south of that.

Those are assets that we are very comfortable with and we think their excellent releasing opportunities whether they be with the same tenant or with new tenants given the strength of the market and the quality of the real estate. So, we are still going to focus on longer term leases and lease averages, but we will look at those types of opportunities.

And we always – and we have – this is not the first year or quarter we’ve done that. We’ve done that, but we have four 40 people on our property management division, we have executed over approximately 1,700 lease rollovers in our company’s history.

We think we are really good at this. We have a great team executing this, so, it’s something that we will certainly consider and have considered because there are some pretty good opportunities there.

Todd Stender - Wells Fargo

That’s helpful John. Thank you. And just going back just to touch on the rent coverage, I think portfolio wide, you said it was 2.6 times. How much can you breakout, can you breakout any coverage whether the – your mandated coverage on an investment grade opportunity, non-investment grade and if you look at it that way on retail, office and industrial?

John Case

Well it’s all on retail because what it is, it’s a four wall coverage. So, we don’t get it on industrial properties or manufacturing. It's almost all non-investment grade. So represents primarily the non-investment grade retail portfolio.

Todd Stender - Wells Fargo

Okay. And then just going back and looking at the Inland portfolio acquisition it certainly closed over few quarters. What was your initial cash yield on that portfolio indeed your investment spread change it all because it was spread out over few quarters and the long term capital that you source was also split out a little bit?

John Case

Yeah as you know I think we’ve mentioned before Todd we are underwriting confidentiality agreement so we can’t disclose specific items about the Inland transaction. But in terms of the yield assume the initial yield was in the range of what we’ve been closing on average the first and second quarter of this year.

And as far as the actual spread that was an accretive transaction for us and we were closing that in stages but the spread remain fairly consistent but as the stock price appreciated in the last quarter it picked up. So I think it was in the 185 basis points area overall.

Todd Stender - Wells Fargo

Okay. And does that confidentiality agreement have an exploration date or that’s kind of ongoing?

John Case

Its one year and to about six months from now we can provide you more detail on that.

Todd Stender - Wells Fargo

Great, thank you.

John Case

Okay, thanks Todd.

Operator

And we will take our next question from Cedrik Lachance with Green Street Advisors.

Cedrik Lachance - Green Street Advisors

Thank you. Just want to go back to the acquisition volume and the pace at which you are buying. It’s interesting to hear of course how selective you are despite you have very low cost of capital. How do you underwrite big portfolios right now and how do you think about the big portfolios that could be available to you versus the more right size acquisitions that are out there?

Sumit Roy

Yeah, looking at both one-off small opportunities, smaller portfolios, we’re looking at large portfolios and we look at any delevel transactions, private and public entity level transactions that maybe out there.

First of all, a transaction has to meet our investment parameters and be strategic for us. And when we look at the one-off in smaller portfolios those are generally trading at higher yields than the larger portfolios, maybe 10 to 20 basis points and then when you look at large entity level transactions, those are priced at 50 plus basis point premiums or lower yields and where those properties in that portfolio will trade on a one-off basis.

So we really look at it from a bottoms-up approach and it doesn’t make sense for the company. And if it does, we’ll move on the larger portfolios, but as we know we have a fairly disciplined and rigorous underwriting strategy.

Cedrik Lachance - Green Street Advisors

And have you seen – outside of entity level possibilities? Have you seen large portfolios becoming available lately?

Paul Meurer

Yes. As Sumit said, our source transaction volume continues to be very high. We are on target to have our second best year ever in terms of source transactions, 80% of what we're sourcing are midsize to larger portfolio transactions.

Cedrik Lachance - Green Street Advisors

Okay. Great. Just going back to the EBITDA question are you able to give us the sense of the range a little bit and perhaps what percentage of your portfolio is with retail tenants that have EBITDA levels and your properties that are at a point where you would considered selling the properties?

Paul Meurer

Yeah. I mean, the EBITDA the rent ranges from less than one on some properties to more than five. So the range is quite board. Certainly when we get to coverage's that are tight or less than one, we look at those assets quite closely and the real estate locations and they potentially go under the watch list. So the range is – the range is broad, but around one to five times.

Cedrik Lachance - Green Street Advisors

And what percentage would be below one for instance or around one to below one?

Paul Meurer

Very few I don't have the exact percentage but very few, I mean, it is pretty much of a bell curve.

Cedrik Lachance - Green Street Advisors

Okay. And then just one final question like everyone, I appreciate the additional discloser on the vacancies, so the properties were vacant. Do you have a sense of the average amount of time these properties have been vacant.

So I guess what I am asking is are there some quasi-permanent vacancies, properties that probably are impossible to release or do you have really assets that you think over a short period of time you should be able to release?

Paul Meurer

Yes. I mean of the vacant properties that we have or have sold the average vacancy has been between six and 12 months. So that should give you an idea of what the vacant period has been.

Cedrik Lachance - Green Street Advisors

Great. Thank you.

Paul Meurer

Thank you.

Operator

And we will move on to Dan Donlan with Ladenburg Thalmann.

Dan Donlan - Ladenburg Thalmann

Thank you and good afternoon. Just one kind of quick question from me John or for Sumit. How many deals have you done this year that have carried a cap rate north of 8%? And is that something that you guys are looking at or is most everything kind of inline with the averages that you brought for the quarter?

John Case

Yes. I mean we have done north of eight, south of seven, down into the mid sixes at all the 10s. The exact percentage that we have done north of eight. Sumit, do you have that.

Sumit Roy

I don’t. But I would say it’s less than 5% of what we have closed its north of 8% cap rate.

John Case

And when you get to that level Dan, you don’t find much that falls within our investment parameters that we want to execute. So it’s certainly price to that level given some of the risk characteristics that the investments caring. There can be exceptions, but not many. And of course, we are talking about cash cap rates versus GAAP cap rates.

Sumit Roy

The only other thing I would John is where we see the higher yielding stuff, it’s been in our expansions and developments where we are seeing, and you will see that in the supplemental.

We are seeing about an 8% yield. But one-off transactions, acquisition transactions add about eight, I would say, it’s a very small percentage of what we’ve closed down and it’s primarily based on what John said. There are assets we see that trade up those levels, but for many different reasons we chose not to pursue those.

Dan Donlan - Ladenburg Thalmann

Okay. Thank you very much.

Sumit Roy

Thanks, Dan.

Operator

And we’ll take our next question from Ross Nussbaum with UBS.

Ross Nussbaum - UBS

Hey, guys good afternoon.

Paul Meurer

Hey, Ross.

Ross Nussbaum - UBS

I joined late, so apologies if you discussed this, but you turned down the DRIP program in the second quarter and what about over $50 million got tapped there, is it your intention going forward, to leave the DRIP open?

Paul Meurer

Yeah, we will opportunistically access that. In the month June, we’ve raised about 53 million at a price just north of $44 a share, I think its 44.35, and as we continue to have acquisition activity that's pretty healthy and that's need to be funded. We’ll opportunistically access that. So we’ll look at it, but it’s – we don’t have a set plan and place to do a certain amount each quarter.

Ross Nussbaum - UBS

I’m just curious how you think about DRIP versus an ATM programs so basically sort of dribbling it retail versus dribbling it institutionally?

Paul Meurer

Well, our direct stock purchase program goes to both institution and retail.

Ross Nussbaum - UBS

Sure. But I imagine most of the buyers were retail than institution on that?

Paul Meurer

We actually control that and actually the majority of the buyers were institutions.

Ross Nussbaum - UBS

Really, that’s interesting.

Paul Meurer

Yeah.

Ross Nussbaum - UBS

I wouldn’t expect that, okay. The other question I have is your friend store over capital on the security there been any comments on their plans to go public, is that a surprise to you or did you think that was going to be on some of these acquisition radar?

Paul Meurer

So, we are focused on running our own business. We know those guys well and have a tremendous amount of respect for Chris and [Mark] (ph). And wish them luck in their endeavors. But we don’t comment on any specific IPOs or any other questions regarding the business of our competitors.

Ross Nussbaum - UBS

I appreciate it. Thanks a lot.

Paul Meurer

All right. Thanks.

Operator

And we will move on to Todd Lukasik with Morningstar.

Todd Lukasik - Morningstar

Hi, good afternoon, guys.

John Case

Hey, Todd.

Todd Lukasik – Morningstar

Most of my questions have been answered I just had one point of clarification I guess on the initial average lease deal but you guys report in. I know generally not an issue where you guys are paying for maintenance CapEx at all, but sometimes I think that’s kept into the leases. The lease deal you report is that include or exclude any outlets that you guys may have for maintenance CapEx in those deals?

John Case

Yes, it’s NOI yield, so if they are recurring CapEx numbers, they are going to be below that line, but we have very little of that in our net lease portfolio.

Todd Lukasik – Morningstar

Got you. Okay, thank you.

John Case

Thank you.

Operator

And this will conclude the question-and-answer portion of Realty Income’s conference call. I will now turn the conference back over to John Case for concluding remarks.

John Case

All right. Thanks, Joshua, and thanks to everyone for joining us today. We look forward to speaking to you next quarter. And have a good end of the summer. Take care.

Operator

And this concludes today conference. As a final reminder, the replay for this call is available by dialing 1-888-203-1112 and using the access code 3275991. We thank you for your participation.

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Source: Realty Income's (O) CEO John Case on Q2 2014 Results - Earnings Call Transcript

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