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Realty Income Corporation (NYSE:O)

Q4 2010 Earnings Call Transcript

February 10, 2011 4:30 pm ET

Executives

Tom Lewis – CEO

Paul Meurer – EVP & CFO

Gary Malino – President & COO

Analysts

Lindsay Schroll – Bank of America

Jeffrey Donnelly – Wells Fargo

Gregory Schweitzer [ph] – Citigroup

Dustin Pizzo – UBS

Omotayo Okusanya – Jefferies & Co.

Richard Moore – RBC Capital Markets

Todd Lukasik – Morningstar

Operator

Good afternoon, ladies and gentlemen. Welcome to the Realty Income fourth quarter 2010 earnings conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator instructions) This conference is being recorded today Thursday, February 10, 2011.

I would now like to turn the conference over to Tom Lewis, CEO of Realty Income. Please go ahead.

Tom Lewis

Thank you, Douglas, and good afternoon, everyone, and welcome to our call where we will review our operations for the year and for the fourth-quarter of 2010.

I have in the room with me today Gary Malino, our President and Chief Operating Officer; Paul Meurer, our Executive Vice President and CFO; John Case, our Executive Vice President and Chief Investment Officer and Tere Miller our Vice President, Corporate Communications.

As always, I must say during this 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 on the company’s Form 10-K, the factors that may cause such differences.

As we usually do, Paul will start with an overview of the numbers.

Paul Meurer

Thanks, Tom. As usual, let me give a few highlights of our financial statements and results for the quarter and for the year, starting with the income statement. Total revenue increased 13.4% to $92.2 million this quarter versus $81.3 million during the fourth-quarter of last year. This increase in revenue reflected a significant amount of new acquisitions over the past year, as well as some positive same-store rent increases for the quarterly period of 1%.

On the expense side, depreciation and amortization expense increased by $2.35 million in the comparative quarterly period, naturally, as depreciation expense increases our property portfolio continues to grow.

Interest expense increased by approximately $3.75 million. This increase was due to the $250 million of senior notes due 2021, which we issued in June of last year. On a related note, our coverage ratios remained strong with interest coverage at 3.3 times and fixed charge coverage at 2.7 times.

General and administrative or G&A expenses in the fourth-quarter were $5,785,000, up from last year on a comparative quarterly basis, but down about $400,000 from the third-quarter of this year.

As we have mentioned over the past year, the increase in G&A this year is due largely to recent hiring and our acquisition in research department. We had reduced G&A in each of 2008 and 2009.

During 2010, our G&A expense increased as our acquisition activity increased, and then we invested some more in new personnel for future growth. Our current projection for G&A for next year 2011 is approximately $28.5 million, which will still represent only about 7% to 7.5% of total revenue.

Property expenses were $1,925,000 for the quarter. These expenses are primarily associated with the taxes, maintenance and insurance expenses, which we’re responsible for on properties available for lease.

Property expenses increased about 10% this year, but our current estimate for 2011 is much lower at approximately $6.6 million or back to prior level.

Income taxes consist of income taxes paid to various states by the company and they were just over $500,000 during the quarter. Income from discontinued operations for the quarter totaled just under $4.9 million.

Real estate acquired for resale refers to the operations of Crest Net Lease, our subsidiary that acquires and resells properties. Crest did not acquire or sell any properties in the quarter and overall contributed income from discontinued operations of $229,000.

As we mentioned in the press release, we did move the three remaining Crest properties held for sale to held for investment as we’ve had strong leasing interest on these three properties, which we plan to pursue rather than selling these properties in the near-term. As part of this move, we did record total impairment of $807,000 in aggregate on these properties.

Real estate held-for-investment refers to property sales by realty income from our existing core portfolio. We sold nine properties during the quarter resulting overall in income of approximately $4.6 million. These property sales gains are not included in our AFFO or in our FFO.

Preferred stock cash dividends remained at $6.1 million for the quarter and net income available to common stockholders increased to approximately $31.8 million for the quarter.

Funds from operations or FFO increased 8.5% to $52.5 million for the quarter. FFO per share was $0.47 for the quarter and $1.83 for the year.

Adjusted funds from operations or AFFO are the actual cash that we have available for distribution as dividend was higher at $0.48 per share for the quarter and $1.86 for the year. Our AFFO is usually higher than our FFO, because our capital expenditures are fairly low and we have minimal straight line rent currently in our portfolio.

We increased our cash monthly dividend again this quarter. We have increased the dividend for 53 consecutive quarters and 50 times overall since we went public over 16 years ago. Our dividend payout ratio for the quarter was 91% of our FFO and about 90% of our actual cash or AFFO.

Turning to the balance sheet, we have continued to maintain a conservative and safe capital structure. During 2010, we were able to permanently finance over $700 million of new acquisitions with $450 million of new common equity and $250 million of 10.5 year bonds at a 5.75% coupon.

Our current debt-to-total market capitalization is only 26% and our preferred stock outstanding represents just 5.5% of our capital structure.

We had $18 million of cash on hand at September 31, and we have zero borrowings on our new $425 million credit facility. This facility also has an additional $200 million accordion expansion feature. The initial term of it runs until March 2014 plus two one-year extension options thereafter. We have no debt maturities until 2013.

So, in summary, we currently have excellent liquidity, and our overall balance sheet remains very healthy and safe.

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

Tom Lewis

Thanks, Paul. What I will do is just run through kind of each facet of the business and then talk how we see 2011 shaping up. Let me start with the portfolio. The portfolio continued to perform very well during the quarter and for the year. I think operations continued to prove pretty much across portfolio and I believe that’s mostly true for not only us and the properties, but most of the tenants that are in the portfolio.

We did not have any significant tenant issues that rose during the quarter and we have nothing on our radar currently relative to tenant issues. It seems to be a fairly stable portfolio that’s increasing modestly, as we move along.

At the end of the quarters, our largest 15 tenants accounted for a little over 54% of our revenue, that’s down about 40 basis points from what it was in the previous quarter. The average cash flow coverage for those tenants is about 2.4 times, so very healthy overall, and all of them have positive cash flow coverage.

Relative to occupancy, we ended the quarter 96.6% occupancy at 84 properties available for lease out of the 2,496 properties. That’s up 20 basis points from the third-quarter and down about 20 basis points versus the same period a year ago.

During the quarter, we had 11 new vacancies that we leased or sold 11 properties. And since we added 163 properties to the portfolio, that’s how you get to 20 basis point increase to 96.6% occupancy.

And I think going forward, looking at the first-quarter, I think we’ll see small but probably continued improvement in occupancy and I would say, flat to up another 10 or 20 basis points would be my best guess as of now, but very healthy.

Same-store rents on the core portfolio increased 1% during the fourth-quarter, as compared to 0.3% in the third-quarter and 0.1% in the second. So, the run rate continues to increase and I think it will continue to do so over the next quarter or so.

To breakdown really where the same-store rent increases came from, we have three of our industries plus kind of the other category that had declining same-store rents, restaurants, entertainment and consumer electronics were most of it, but the declines in the four areas were only about $170,000 of rent.

Three of the industries rent had flat same-store rents and then 23 saw some type of same-store rent increases. About half of that came from theaters during the quarter and then some decent increases on our childcare, convenient stores, and auto service portfolio. The balance of it is pretty small.

The 23 industries together, we had increases of about $938,000 and that gave us the net gain of $768,000 which is 1% increase in same-store rent.

We’ve been talking for a couple of quarters of seeing the portfolio improvement, but and summer might be the bottom, absent a double dip in the economy, we continue to think that and continue to think we’ll see modest increases as we move into 2011 in the operation of the portfolio.

Relative to diversification, as I mentioned a second ago, we’re at 2,496 properties. That’s up 154 properties from last quarter. 32 retail industries, 122 multiple unit tenants and still in the same 49 states.

Relative to industry exposure, there’s been a little movement during the quarter. Restaurants continue to come down, and that’s now under 20%, but looking at the first-quarter, the run rate is probably closer to 18% and it is likely in the first-quarter it will become our second largest industry.

Convenience stores are at about 17%, but given the recent SuperAmerica acquisition, that should be up to about 20% run rate in the first-quarter. And after those two fairly large industries, you drop down to theaters, which is about 8.6%.

So, we’re in pretty good shape relative to diversification and we continue to be. Our largest tenant at 5.9%, as you can see in the release, is Diageo. Second is AMC at 5.5%. And as I mentioned earlier, the top 15 are 54.4% of revenue.

To give you an idea of how they really declined as a percentage of the revenue, when you get to the 15th largest tenant, you can see it’s about 2.2% of revenue, past our 27th largest tenant, the balance of the 95 other tenants are each less than 1% of rent, so we remain fairly well diversified.

From a geographic standpoint, California is our largest state at 10.8, about half of that is Diageo and they really booked their revenue across the country, so it’s a little less I think economic impact of a 10.8% exposure to California and then Texas at 8.8%, Florida at 7.5%.

From the acquisitions we made and properties that were released, the average remaining lease length on the portfolio remains very healthy at 11.4 years. I think that’s up a bit from last quarter.

So I think overall in the portfolio it remains quite healthy and again no tenant issues have come to our attention and we feel fairly positive about portfolio.

Moving on to property acquisitions, obviously, during the fourth-quarter, we were very active and acquired 163 properties for just under $411 million. Cap rates on the purchases were pretty good at 8.1%. Average lease terms of just over 15 years.

And from a diversification standpoint, the 163 properties were leased to 16 different tenants and 10 different industries, the largest was, as we noted in the release, was the $248 million of that, that was the SuperAmerica transaction that represented about 135 properties.

For the year that got us to 186 properties acquired for $713 million. Average lease yield was 7.9%, average lease term 15.7 and good diversification, 186 properties leased to 20 different tenants in 11 different industries.

The $713 million I think is the second largest total amount of acquisitions in any one year for us, largest for the core portfolio and obviously, very pleased with the results as I think these acquisitions really help us in driving our FFO growth here in 2011.

We’ve said for a long time for those of you that have followed us that, generally, we’ll acquire $10 million, $15 million, $30 million each quarter just by being out there in the business, and then that will get us to $100 million or so in acquisitions, and then after that it’s really a function of how many larger type acquisitions we work on in our investment committee.

And then if we end up doing none of them, two or three of them and that’s really going to drive the acquisition numbers. So it can be fairly lumpy year-in and year-out and also certainly, quarter-to-quarter. This year we did have a couple of those that came through, the larger transaction, and that’s the reason for having a substantial year for acquiring properties.

I mentioned Columbia [ph] second ago and I think this is a great example. For 2010, we did $27.5 million in acquisitions in the first-quarter, $261 million in the second-quarter, only $12 million in the third-quarter, and then $410 million in the fourth-quarter, and that type of movement is fairly typical when we are relying on doing some larger transactions.

Usually in this call, as I do every year, after the completion of the year is to try and give you some idea of transaction flow that we went through, and there is a quite a few numbers in here. And if you miss one or two, hopefully, you can pick them up from the copy of the transcript.

If you look at 2010, there was $5 billion to $5.5 billion that kind of came through the door, and not all of that actually ends up really getting underwritten or in committee, but relative to what went into the investment committee we had 70 different transactions committee worked on this year.

They represented about 1,500 properties. The offer value of those was just over $3 billion. And the average cap rate offered was about 8.8% with a range of 7.5 cap up to about 10.8 capital, so, 70 transactions, 1,500 properties about $3 billion that went through committee.

We ended up buying properties in 11 different transactions of some size of the 186 properties, obviously I talked about earlier in $714 million. Cap rates were 7.9%. So, if you take that $3 billion that went through the Committee and that $714 million we acquired, that’s buying about 23.5% of what we looked at in Investment Committee.

To put those numbers in prospective, then keeping those for nine years now since 2002 and if you look back over the nine years and look at the value of properties that went to the Committee or the serious deal flow it averaged about $2.9 billion a year and that’s low of just over $1 billion up to a high of about $5 billion and we did $3 billion this year. So, pretty much average for the last nine years.

The average we have bought out of that over the last nine years is about $385 million a year, but that’s varied from $58 million at the low and the high of $770 million versus $714 this year.

If you run those percentages, the average over the last nine years is acquiring about 13% of what went through Committee with a low in one year of 4% and high of 26% and about 23.5% this year.

Cap rates, the average has been about 9% over the last nine years, low of 7.9, high of 10.4, and at 7.9 it was this year. Again, much more comes in the door then ends up in the Investment Committee and the flow is about half, ends up going to Committee of what we take a quick look at and then buy anywhere from 4% to 25% of that in this year, because of a couple of large transactions of this 23.5%.

If you look at some of the transaction flow for 2010, it’s down from a few years ago, but I think averaged for the last nine and I think just a pretty good flow given the recovery in the economy and we’re starting to see things open up relative to seeing transactions.

Going back on cap rates for a minute, they’ve obviously come down over the last nine years or so as interest rates have declined, and I think as also net leased real estate has become a little more mainstream from an investors standpoint.

It’s interesting to note that the spread of cap rates over the 10-year treasury for us, if you look back over the last really 16 years, it’s averaged about 480 basis points the cap rates were over the 10-year treasury.

Looking back on the 10-year, we did some averaging, averaged about 3.11% this year. Our cap rates ended up at 7.91%. So, strangely enough, this year it was about 480 basis points spread over the 10-year on cap rates.

I think the main thing relative to our cap rates this year for us was moving up the credit curve for the year with our acquisitions. Unlike in previous years, over half of the acquisitions we made this year were with investment grade rated tenants.

That probably took 50 to 60 basis points off our yields for the year, but given we were able to maintain very good spreads over our cost to capital, we’re pretty pleased with that.

If you look at the acquisitions market now, as we see it, we continue to see a very good flow of acquisition opportunities to work on. Transaction flow to look out, it’s certainly above where it was a year ago and pretty steady just coming through the door.

I’d really say that the volume of opportunities accelerated in the second half of the year and looking here in the first-quarter, it’s really staying at about that rate. So, there’s a fair amount that we’re underwriting.

We’re fairly active in committee and it will be interesting to see what actually gets through and what we end up closing on, but we have a lot to look at.

From an industry standpoint, in terms of transaction flow as always, we’re seeing lot of transactions in the restaurant industry and the convenience store industry. But after those two big ones, what the theme seems to be is that there are number of sellers out there that are looking at cap rates and interest rates and looking into the future and feeling this might be a good time to go to market, so I think that’s why things have been accelerating.

And then as you’ve probably noted there has been some pickup in the M&A environment and that generally can bring some transactions out of the woodwork that we can look at.

Cap rates continue to decline, I’d say modestly, still given the demand for yield in the world and the number of people out there with money that are looking to buy. I think we generally look for cap rates to be around 8% right now for good transaction. I think that’s pretty much like last quarter, depending on the credit of the tenant.

Last year we’re at 7.91% average cap rates and as I mentioned a minute ago that was influenced by doing a lot more moving up the credit curve with investment-grade tenants.

So if we’re thinking around 8% or so today, it’s really not cap rates we think moving up, but it’s just a function of not being sure how much will be working up to credit curve this year, so I’d say modesty lower cap rates out in the marketplace, but we should probably hang somewhere around 8% or so.

Relative to spreads for us, if you look at the historical spreads over our nominal cost of equity, which is basically taking a forward FFO yield and grossing it up for issuance purposes, I went back and looked over the last 16 years or so, and generally, the average cap rate we’ve gotten on acquisitions have been about a 105 basis points over that gross stuff FFO yield number.

Right now it’s closer to 175 to 200 basis points. So, obviously a pretty good environment to take advantage of it, we can find the transactions we like. We’re optimistic about having a decent year in acquisitions, but again it’d just be, what happens relative to some of the larger transactions we get to look at.

For our guidance this year, obviously, with the growth in the acquisitions last year that has started to grow the top line which you can see in the numbers and given the fourth-quarter activity, I think that will continue and be very additive this year.

You see the guidance is $1.96 to $2.01 that’s 7% to 10% FFO growth. In that number, we’re assuming only about $250 million in acquisitions for the year at 8%, and also assuming that the portfolio continues to be very stable and grow just a bit, and then that should allow us to continue to grow the dividend this year, and at the same time, drop our payout ratio a fair amount.

And then if the acquisition numbers will get bigger than $250 million that will give us some more flexibility relative to additional dividend increases or lowering the payout ratio. So, we’ll see how that unfolds.

As Paul mentioned, the balance sheet is in good shape. Access to capital is great right now. There is no balance on our $425 million line, and we have some cash on hand, and with no debt coming due and no mortgages, I think in pretty good shape from a capital and balance sheet standpoint to acquire this year.

I’ll just conclude by saying, good stability in the portfolio with modest improvement and great year for acquisitions, which will help us for FFO this year and we’ll see what we can get done relative to the acquisition environment right now.

With that, I’ll open it up for questions, as Douglas, will come back and say, hi to us.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Lindsay Schroll with Bank of America. Please go ahead.

Lindsay Schroll – Bank of America

Hi, guys. Can you discuss some of the reasons for increasing the capacity in the line of credit?

Tom Lewis

First, we wanted to redo the line of credit early just because we thought it was a good time, we wanted the capacity. But as we got into the second half of the year and started seeing the volume of opportunities increase and some of them being a little larger, we thought it’s prudent given the size of the Diageo earlier in year and then we were already working on the SuperAmerica and knew that if something else came around, it would be very helpful to add more capacity.

So, the $425 million was a decent guess of what that size should be and then the $200 million of quoting on it I think gives us good flexibility to be working on a couple of things if we needed to do it and be able to close them and not be forced into the marketplace or to go after the term loan very quickly.

Lindsay Schroll – Bank of America

Okay, great. And what are you seeing in terms of large portfolios in the marketplace?

Tom Lewis

As I mentioned, there is more and more, I think as you see more and more M&A activity, that’s really what it’s going to key off up and there were probably three, four or five in the second half of the year really moving later into the year that we were looking at, of which we were able to do some, and that volume is similar today. And they range in size anywhere from $50 million to $300 million, $400 million. And typically if you get 10 of those through the door, we’ll end up closing on a couple of them, but it’s hard to see how much.

But it’s fairly active and M&A driven and just as I said earlier a few people who had some good size portfolios they have accumulated over the years, whether a developer or an institutional holder and if they hadn’t gone to market in the last few years because of the state of the economy and not a lot of people investing I think they are seeing it open up and thinking maybe it’s a good time to go.

Lindsay Schroll – Bank of America

Okay. And last question. You mentioned I think that net triple net lease investments are becoming more mainstream from investor standpoint. So, do you think the level of competition is increasing or remaining the same? How do you see that playing out in 2011?

Tom Lewis

Yes, it’s very competitive out there. I wouldn’t want to say it any other way, there’s a lot of capital floating around trying to find a home. I think as long as I’ve been in this business, there’s always been ourselves or maybe one other people out actively buying. And then there is usually, every few years, a marginal buyer that needs to put capital out and they’re out there being very aggressive. I can’t think of a time when that wasn’t the case, and it’s a case today.

And then I think you’re seeing more of some institutional players that might not have been doing triple net that are today. So, there’s a lot of capital out looking at it. Each of these companies have different characteristics. So, I think it will be very competitive this year, but I think we’ll be able to hold our own given our cost to capital.

Lindsay Schroll – Bank of America

All right. Great. Thank you.

Operator

Thank you. Our next question comes from the line of Jeffrey Donnelly with Wells Fargo.

Jeffrey Donnelly – Wells Fargo

Good afternoon, guys.

Tom Lewis

Hi, Jeff.

Gary Milano

Hi, Jeff.

Jeffrey Donnelly – Wells Fargo

Tom, how do you think net lease, I guess initially yields will respond to the prospect of rising interest rates over the next few years. Do you think they will resist some degree of increases or you think it’s going to be sort one for one rise?

Tom Lewis

That’s a great question. Traditionally, when interest rates moved to some degree one way or the other, there was generally a pretty good lag before the property started moving cap rates, and that’s whether they were going up or down. I think that would be the case. But if you look maybe six months to 12 months beyond interest rates really starting to move, you’ll see cap rates starting to move also. But having them through this now a number of times, if you saw 100-odd basis points increase in interest rates, I think you’ll see cap rates go up 10 or 20 basis points for six months and then start catching up. I think they would eventually.

Jeffrey Donnelly – Wells Fargo

How do you think about your own cost of capital in that scenario, because right now you enjoy a fairly widespread versus where private market initial yields are on net lease. Have you look at sort of how Realty Income has made its average cost of capital response to changing interest rate?

Tom Lewis

That’s an equation with multiple inputs and outputs. But it’s interesting if that increase in interest rate is due to higher inflation, in anticipation of inflation, as you know, capital flows adjusted that and real estate is one of the places they go to, so you could see an environment where maybe a debt cost might be rising, but on the equity side for a while at least you might get the benefit of some additional flow.

But overall, when I look at it, I think cost to capital will probably go up and would probably go up a little faster than cap rates would and that would be margins would come in or spreads would come in. I mentioned today, our equity cost of capital were about 175 to 200 basis points spread, and I think that gets narrowed because if you look at the last 16 years, it’s only been 105 basis points.

So, taking the opportunity now to acquire if you can find the right thing, this is the time to do it, but there is enough spread out there right now that you could see the spread close between our cost of capital and smart cap rates and it still be pretty good time to acquire for a while.

Gary Malino

The other thing, Jeff is on the expense side obviously, we have no variable rate debt, so we would not get hurt from a standpoint of any current cost on the debt rising that might not be the case for others. And then our property expenses are naturally going to not be as affected because we’re triple net. So in terms of the existing portfolio and our existing cost structure, rising inflationary environment does not hurt us.

And then as Tom mentioned, if debt rates go up a little bit, we think that (inaudible) product could be more competitive as long as they don’t rise dramatically, we like the debt market to be alive and well for our tenants and for folks out there doing transactions.

Tom Lewis

Jeff, one other thing too is, given spreads got as wide as they did this year, I wouldn’t say it was a campaign, but I would say one of the things we’re looking at is, saying, this is a good chance to move up to credit curve, add some diversity to the portfolio relative to some investment grade tenants, and give them a large spread, still have a good spreads to grow their earnings.

If you saw interest, if cost of capital going up, it probably causes to do less of that and return more to our traditional things. So we may be able to maintain the spreads a little bit for a while, but ultimately interest rates go up, cap rates will lag it and I think everybody participates in them.

Jeffrey Donnelly – Wells Fargo

That’s helpful. I guess one last question is, after you did the Diageo deal last year, you talked a little bit about being more open to, I would call hard assets where I guess I’ve characterized this and I will (inaudible) may be just not detail-oriented, but where you felt like the EBITDA from those assets was inseparable [ph] from the properties operation itself, like farm land or factories and vineyards and things of a such. Have you guys made any headway on assets like those, if you have to target for what I guess I just maybe call them non-retail assets in your portfolio?

Tom Lewis

We wouldn’t mind, and I really look at this over a period of 10 years, kind of widening out the net of it in the portfolio, so very slowly, we start looking at some other areas. Let me kind of go on for just for a minute. It’s interesting. We have six industries and we went public, we are in 32 today and I’d like 40 or 50 if I could, because the real game is allocating capital where people need it and as time goes on, different industries, different need more or less money.

While retail will continue to be huge, I think the consumer maybe a little less positive in future years than they were in the past, given they levered up their balance sheets pretty well.

And there was a huge amount of new store growth, and we just see a more moderate environment kind of looking into the future, and given that net leases become a little more mainstream, it probably make sense to widen that out, if you can find investments in other areas that have very similar characteristics to support your underwriting.

So, I think really forward is if you look at what we’ve done, traditionally, we’re looking for tenants that have multiple cash flows and retailers with multiple stores. If you look at Diageo, it’s somebody with 65 consumer brands in 105 countries. So, the same word owning is not really relying on that fit. That’s the one cash flow stream they have.

If you look in other areas if they are not large owners of real estate as a very critical part of their business, probably doesn’t make sense, but when you get the key for us is that the real estate is absolutely necessary in generating the revenue and EBITDA and then trying to tie that EBITDA to the properties as you mentioned.

Long-term lease, same characteristics, BBB, net lease and spread. What we’ve done in retail over the years and I think the way we looked at Diageo too is anytime there is an issue in credit underwriting or you know the property is really important for creating their EBITDA, but it’s hard to support exactly how much EBITDA that property does, then you either move up the credit curve.

If you recall years ago when we did the Regal transaction doing a structured transaction or something where you maybe only buying land with a lot of assets on top of it, where you are relying on residual value which is we’ve done for about 10 years now in the entertainment areas.

So, that’s how we look at it and I think we’ve slowly moved into new areas in the past, I’d like to widen it, but I don’t think it’s going to be some massive campaign. Now we’ve changed where how we’re investing the capital out there.

But if ten years from now I woke up and there was 10% or 20% or 30% of the assets that were really outside of retail, but still had all those characteristics in triple net lease, I think I’d be pretty happy about it. As always, I think it’s going to be at least do a lot of research, crawl for a while, then walk for a while and if it works, then you run a little harder.

Jeffrey Donnelly – Wells Fargo

The more likely outside, I guess, but I call it consumer area like more of a corporate. Again, vineyards or maybe farmland or like energy power plants, I don’t know, I’m just thinking a lot here.

Gary Malino

We started thinking about this about four years or five years ago. And the kind of first thing is, if you look at the company, we’ve kind of followed the baby boomers over the years. And so, you sit around and just off the top of your head, you go, okay, how old is this large group of demographics and what’s in the future, adult day care, drug stores, health and fitness, health food, medical equipment, that type of things you start thinking, but then it really happens slower than that.

So, while I think it will happen, I don’t think it’s going to be anything way out there. We started looking at lines four years or five years ago, did the research, didn’t think we’ll get there, and then Diageo came up. We also did some additional Diageo in the fourth-quarter, about $30 million worth, but beyond that, I don’t know not else we do in wine. So, we really don’t have wine target. I think it’s just being open to two things that come across our desk that fit the characteristics.

Jeffrey Donnelly – Wells Fargo

I’m sure you’d like to do due diligence on the golf course, so…?

Gary Malino

I’d love to do the due diligence but I doubt I’d like to invest.

Jeffrey Donnelly – Wells Fargo

Thank you, guys..

Operator

Our next question comes from the line of Gregory Schweitzer [ph] with Citigroup. Please go ahead.

Gregory Schweitzer – Citigroup

Hi, guys.

Tom Lewis

Hi, Greg.

Gregory Schweitzer – Citigroup

I had a couple of questions on the SuperAmerica deal. Perhaps you could walk us through how you are comfortable and underwrite, any potential environmental concerns that went along with the same-stores and SuperAmerica (inaudible)?

Tom Lewis

As you know we’ve been in that industry for nine or ten years before we did that about 70% of revenue and done a lot of transactions. It really starts for us is the risk in that business changed a fair amount of number of years ago when everybody in America that operates a gas station or convenience store that sold gas had to replace their tanks and put in new double vault tanks with alarms and so I think that game changed a little bit.

And then secondarily, a lot of studying over time to see how much environmental liability really comes out of gas stations to convenience stores, which is a lot less than you would think.

The next thing then is working with a large enough entity that is going to basically take on that liability for you, which all of the tenants do their first responsible for it rather than us, so, as long as you have a viable tenant, it’s not you. You then go out and do phase ones, you look at the history, and then very often what we do is require the tenant most of the time or all the time to have environmental insurance above and beyond just indemnifying us.

We also look very carefully at each state that we invest in and watch their situation. Do they have a fund, who would have access to it, under what circumstances, then we carry our over own environmental liability insurance which we’ve never had to use.

So, if you work through all of that and you look at the history of convenience stores, particularly when they are leased to a larger entity there has been, we really haven’t had evidence of environmental liability in this industry. But that’s kind of how you got there.

And in this particular case, this obviously was a spin-off the division at Marathon Oil, which included refinery and a pipeline and a very large support services and 160 plus convenience stores. So, a large public company like that particularly in these days of SarbOx has a lot of control. So, if you walk through all of that we get pretty comfortable and I don’t know if I left anything out, Paul?

Gregory Schweitzer – Citigroup

Got it. Thanks. And apart from the locations, do you have any insights on what differentiated these (inaudible) Speedway brands that Marathon ended up keeping?

Tom Lewis

I think it was more of a geographic movement tied to the pipeline and the other operations, and over as you’ve seen in recent years it was kind of the trend from the major royal kind of moving out of retail and focusing on the other end of their operation. But I really don’t think there was a lot.

If you look at these convenience stores, they are the poster child for what we look for in the industry. They are first of all, over an acre of land. And as you know, you want both the convenient store and gas station, so you can amortize to cash flows over one rent, and these averaged 1.14 acres.

Second thing in that business is you could see a lot of convenience stores of maybe 800 or 1,000 square feet, but, until you get a closer to 2,000 square feet, it’s hard to really merchandise those stores effectively, and the industry about 30-year revenue and two-thirds of your profit book comes from the convenience stores.

So, to the extent that you can get larger stores, they can be effectively merchandised and these average 3,500 square feet, which were on the large side of what we bought, and that 6.5 multi pump dispensers and the card readers and everything you would see.

The other thing though is, there are not new stores, the average age is about 20 years old which is surprising given the size to that type of size is not typical back then. All of them have basically being reengineered and lot of money put into them over the last seven years to eight years.

For us, if you look at Speedway, there are similar large stores and those that are kind of the most valuable I think because of the revenue stream that can be thrown out from a larger store that can be merchandise are what people look for the industry and these had them. I think it was more geographic.

This one was unusual for us, and typically when we do a portfolio spread out around a lot of state. And in this one, there was I think 160 convenience stores that came with it, of which we bought 135 and the vast majority in one metropolitan area, which is Minneapolis.

So, if you look at this size of store concentrated in a metropolitan area and we were able to get them at about $1.8 million per copy we felt very strongly that they were good stores. I don’t it was choice of these were Speedway for them, but I don’t know you’d have to ask them.

Gregory Schweitzer – Citigroup

Okay. One more in that line. What are the gas gallons sold metrics versus the national average?

Tom Lewis

They are higher but as you know we really can’t report our tenants operating numbers nor their financials. They get to do that but they were substantially higher which is something that we really look at and same with merchandize. I think it is very good purchase for TPG and ACON.

Gregory Schweitzer – Citigroup

Okay, thanks so much.

Operator

Our next question comes from the line of Dustin Pizzo with UBS. Please go ahead.

Dustin Pizzo – UBS

Hey, thank you. Tom, as you are looking at acquisitions today and then 2011 what you currently have either under contract or under LOI?

Tom Lewis

I respectively reported what we bought at the end of the quarter. The exception we do to that is, if we have something big that we have tied out and we know that’s going to close and we are not in that situation today.

So, like last year when you looked at 27 million 260, 12 million 400 its very, very difficult for us to know quarter-to-quarter, but we don’t report what we have under contract and have tied up because how you define that really drives what those numbers are and until you absolutely have it under contract in your (inaudible) and you have completed your due diligence we don’t for close.

Dustin Pizzo – UBS

In the guidance the way that the acquisitions are factored in that are you assuming that they inevitably occur throughout the year?

Tom Lewis

Generally, what we do is assume that the majority will close at the end of the quarter, as a lot of times they do, so, we’ve just divided it up pretty much at the end of the four quarters throughout the year.

Operator

Our next question comes from the line of Omotayo Okusanya with Jefferies & Co.

Omotayo Okusanya – Jefferies & Co.

Just a quick clarification. You mentioned that the rent coverage ratio on the portfolio right now is 2.4 times.

Tom Lewis

Yes.

Omotayo Okusanya – Jefferies & Co.

That number, if I remember correctly, used to be at highest 2.7, correct?

Tom Lewis

Yes. Actually, that’s a very good memory. It was about three, four years ago, 2.77 I believe. That’s the number in ‘06 and then came up and was lower a couple of years ago. I think it was like 2.47 a couple of quarters ago and 2.42 is what it came in this time.

Omotayo Okusanya – Jefferies & Co.

Could you talk a little bit about which particular industries are driving that average a little bit lower?

Tom Lewis

Okay, now you’re really going to challenge me, Omotayo, because while I have that stuff, trying to remember off the top of the head. It’s interesting, during the recession, I will tell you that it was, if you recall, we talked a lot about the RB business and our tenant net industry. What’s interesting, they’re now in the upper half in cash flow coverage and RB sales were up 48%. So I know that one flip-flop big the other way.

I think restaurant continues to be challenged. That’s the industry that I think hasn’t gotten a lot of traction. The fast food guys have done pretty well, but outside of that, restaurants, while they have made improvements and they’ve rationalized their business and kept capital costs, while a lot of them had a chance now to fix their balance sheet, their business in no way has come roaring back, so I think those are the ones that if you look across, are probably the weakest. After that, everybody is looking pretty good.

Omotayo Okusanya – Jefferies & Co.

So, just because of restaurants are not such a big part of your overall portfolio, it really skews the mix?

Tom Lewis

Bob about 17% and I was going to get the range, the cash flow coverage are somewhere around 1.5 and then go up in the high threes by tenant, so that’s kind of the range.

Omotayo Okusanya – Jefferies & Co.

And then just given all the long competition you had mentioned increasing the available cash in the market. Are you so much surprised that 1031 transactions have not thought of coming back?

Tom Lewis

That’s a very interesting question and the answer is I don’t know if I’m surprised, but it’s a good observation that the money that’s floating around is in institutional hands and I think it speaks to the bifurcation that everybody is noticing in the economy that it’s very much have, have not society and those institutions that are large and can get access to capital out there and those that are smaller really struggle. So, given that’s the case, it’s kind of the same in our markets, so 1031 is soft but there is a number of institutional players with money.

Operator

Our next question comes from the line of Richard Moore with RBC Capital Markets.

Richard Moore – RBC Capital Markets

Given all the capital time that you were talking about that is out there and then these other good ideas that you’d like to pursue for other sectors, other concepts. What do you think about selling some of your assets at a bigger pace than what you’ve done historically?

Tom Lewis

It’s interesting as we walk through there, if you get a let’s say an acquisition pipeline that’s very, very, very large then you can do it and it can be somewhat accretive and we haven’t really had the opportunity to do that too much in the past. It’s been modest sales.

As we go forward looking in the portfolio, I don’t think it’s anything in the cards for this year, but it is something that we’re really thinking about relative to looking at various industries and lease durations and knew what opportunities are out there.

But something that’s hanging in the back of our mind that, nothing that we see coming really for this year, unless all of a sudden we see a huge amount of acquisitions coming in. And then I think you can make some major move in the portfolio without upsetting the revenue stream too much.

Richard Moore – RBC Capital Markets

I see, but even to take the opportunity to go up the credit curve a bit even with a little bit of loss of FFO or capital or cash flow it wouldn’t interest you to get rid some of these?

Tom Lewis

It would interest me, but after a very happily getting through the recession was stable FFO, I’d like to grow it a bit, get the payout ratio, down raise the dividends a bit, and that will give us a flexibility to start doing that.

Richard Moore – RBC Capital Markets

And then this is the time of year went when retailers seem to have their difficulties if they’re going to have difficulties, how are you guys thinking about any troubled tenant exposure?

Tom Lewis

It’s interesting, you’re absolutely right, they go through the holidays. Of course, most of our portfolio is service-orient, not tradition or retail, the guys that are in the malls and really booking the huge Christmas sales. So, I think we’re less exposed to that, but we have seen January, February, March is the time, but there is really almost nothing going on in the portfolio. I did a scan of the major tenants out there and we have an absolute nothing come on our radar screen right now for this year, which is one of the reasons we’re fairly positive about things.

Richard Moore – RBC Capital Markets

Last thing I had was there is obviously been some demand increase from the big box type retailers and others out there and I’m wondering how you’re coming on the 84 leases, obviously, you did some this quarter and it came back to 84. But what do you think going forward for the ones you have that are vacant that you’re trying to lease out?

Tom Lewis

We’ve actually made some good progress that it doesn’t show in the numbers because we had 11 in and 11 out, but one of things that’s happened is, you are right there is some demand on the larger size and so some other re-leases that we were able to do was on the larger space. As you know we calculate our vacancy by taking the number of vacant, 84 and divide it by the number of properties 2,496 and that gets you to the number.

What we also track internally is the ones that are vacant is what percentage of the revenue they represented before they went dark. Generally they match up pretty evenly, but right now it’s 3.4%, just on a numerical from a vacancy standpoint, but it’s only 2.7 on a revenue side. So, we actually did, what we did move was some larger space, which helped us out in that. The numbers were actually little better than they look.

Richard Moore – RBC Capital Markets

So the remaining ones ahead are smaller assets in general?

Tom Lewis

Yes, they are. There is a lot of child care hanging out in there on those numbers that we’re working on.

Operator

Our next question comes from the line of Todd Lukasik with Morningstar.

Todd Lukasik – Morningstar

Just Paul quickly first, I don’t know if you got the lease termination fees for the quarter?

Paul Meurer

Lease termination fees for the quarter, I’ll find it while we speak.

Todd Lukasik – Morningstar

Other question I had followed it on with the interest rate question you guys fielded earlier. I’m just wondering what your expectations are with regard to inflation. If you want to hit on any other key points about how inflation impacts the portfolio performance and whether or not expectations of rising inflation rate would change? How you think about permanent capital between debt preferred and common?

Tom Lewis

Sure. I will let Paul answer that question you signed it and then I’ll come back.

Paul Meurer

$350,000 for the quarter.

Todd Lukasik – Morningstar

That’s quite a bit lower than run rate prior to that, right?

Paul Meurer

Yes, I mean, let’s see, compared to quarter a year ago, that was about $80,000, but on a year-to-date basis, that’s actually down. We had that just under $500,000 this year for the year whereas we had over $700,000 in ‘09. One, it was stressed for some tenants, there was obviously some negotiations going on where they wanted to exit a lease early and that sort of thing. We’re not having as many of those discussions today.

Tom Lewis

Relative to kind of inflation and the impact on our thinking and capital structure and what we do? It’s interesting. I thought, we were going to have a major recession for about three years before we had one, so I think that there could be some inflation in the offering, but I’ve learned not to try and guess what it is. Just that we are more likely now to have it in the future perhaps than in the past, given monetary policy out there and what you’re seeing in commodities and some other areas. But it does.

One of the things we’d like to do is really relates more to the impact than inflation might have on interest rates and higher interest rates, given how low we are and after 30 years of declining interest rates, trying to look forward long-term and assume that we’re more likely than not going to see increasing interest rates, given how low things are and so we have more of a prejudice even than we had in the past for utilizing equity, although I’m sure at some point, we’ll use debt.

If you look into last few years, our debt on the balance sheet has started to decline. Debt-to-market cap like 26 something. And we’d like to bring that down further because I think in the next year or two or three, everything’s just fine.

But if you start looking even in modestly levered balance sheet like ours and refinancing three, four, five years down the road higher interest rates, you can have some FFO pulled out of the numbers, and to the extent that you continue to have debt on, that could be sizable.

So I think it really leads us towards trying to keep a very modest amount of leverage on the books looking over the next five, six, seven years and then kind of being tactical in the short-term.

Relative to the revenue side in our leases, one of the things that’s happened over the last 25 years is given there was a big bout of inflation early in our business as retailers really got away from allowing landlords to have a lot of inflation increases in the leases, and while they are talked about a lot, most triple net leases don’t have a lot of them.

We’ve built into ours that we don’t straight line as you know anywhere 1% to 2%, 2% plus per cent and when you get much beyond that and you look at inflation, it’s hard to adjust. That’s been a major program we’ve been on for couple years. But given the size of the portfolio and how difficult it is an acquisition it is very hard to move that number.

But looking back two and half years ago, only about 6% of our leases really adjusted well for inflation, either through being a flat percentage of sales or CPI, we now have that up to about 18%, but it’s very slow going trying to move that needle.

So if you had higher inflation, higher interest rates, I think we would adjust decently on the revenue side. But on the expense side, we want to make sure it doesn’t hurt us, so it probably leads us to lean more towards equity than debt.

Todd Lukasik – Morningstar

And thinking about common versus preferred, if you think there is going to be an inflationary environment, would you have a preference for preferred equity?

Tom Lewis

We’ve used preferred. If you look at the differential in price today, it’s substantial. If you do a kind of the forward FFO yield, grossed up for issuance on equity, you get a little over 6% today, not much and fall off your issue preferred.

Todd Lukasik – Morningstar

We could do something inside of seven, but from an all in cost basis you are around 7.

Tom Lewis

So you give up 100 basis points today, but you kind of fix it. It could be attractive. We’d have to watch it, but I don’t think preferred will be a huge part of the capital structure, so I think we think equity first, preferred second and then debt when tactically it makes sense for us.

Like Diageo, when it was a fairly large acquisition in the new area and we weren’t sure quite what the impact that marketplace was going to be, and we were able to finance first with debt and turns out the market was seem to be happy with what we bought, came back with equity and that’s kind of like we want to use debt, but we used both.

Operator

This does conclude Realty Income’s question-and-answer session. I’ll like to turn the conference back over to management for closing remarks.

Tom Lewis

Thank you everybody for taking the time today, and we’ll talk to you soon at one of the meetings out there, or hopefully at the next call. Thank you very much. Thank you, Doug.

Operator

Thank you, sir. Ladies and gentlemen, that does conclude our conference for today. We like to thank you for your participation, and you may now disconnect.

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