Attached files

file filename
EX-31.1 - EX-31.1 - REALTY INCOME CORPa15-7136_1ex31d1.htm
EX-10.1 - EX-10.1 - REALTY INCOME CORPa15-7136_1ex10d1.htm
EX-32 - EX-32 - REALTY INCOME CORPa15-7136_1ex32.htm
EXCEL - IDEA: XBRL DOCUMENT - REALTY INCOME CORPFinancial_Report.xls
EX-31.2 - EX-31.2 - REALTY INCOME CORPa15-7136_1ex31d2.htm

Table of Contents

 

GRAPHIC

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

 

FORM 10-Q

 

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2015, or

 

o Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission File Number 1-13374

 

 

REALTY INCOME CORPORATION

(Exact name of registrant as specified in its charter)

 

Maryland

 

33-0580106

(State or Other Jurisdiction of
Incorporation or Organization)

 

(IRS Employer Identification
Number)

 

11995 El Camino Real, San Diego, California 92130

(Address of Principal Executive Offices)

 

Registrant’s telephone number, including area code: (858) 284-5000

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x   No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o   No  x

 

There were 232,538,873 shares of common stock outstanding as of April 23, 2015.

 



Table of Contents

 

REALTY INCOME CORPORATION

 

Index to Form 10-Q

 

 

March 31, 2015

 

 

PART I.

FINANCIAL INFORMATION

 

Page

 

 

 

 

 

Item 1:

Financial Statements

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets

 

2

 

 

Consolidated Statements of Income

 

3

 

 

Consolidated Statements of Cash Flows

 

4

 

 

Notes to Consolidated Financial Statements

 

5

 

 

 

 

 

 

Item 2:

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

 

 

 

 

 

Forward-Looking Statements

 

20

 

 

The Company

 

20

 

 

Recent Developments

 

23

 

 

Liquidity and Capital Resources

 

26

 

 

Results of Operations

 

31

 

 

Funds from Operations Available to Common Stockholders (FFO)

 

36

 

 

Adjusted Funds from Operations Available to Common Stockholders (AFFO)

 

37

 

 

Property Portfolio Information

 

38

 

 

Impact of Inflation

 

45

 

 

Impact of Recent Accounting Pronouncements

 

45

 

 

Other Information

 

45

 

 

 

 

 

 

Item 3:

Quantitative and Qualitative Disclosures About Market Risk

 

46

 

 

 

 

 

 

Item 4:

Controls and Procedures

 

47

 

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

 

 

 

Item 2:

Unregistered Sales of Equity Securities and Use of Proceeds

 

48

 

 

 

 

 

 

Item 6:

Exhibits

 

48

 

 

 

 

 

SIGNATURE

 

51

 

-1-



Table of Contents

 

PART 1. FINANCIAL INFORMATION

Item 1.   Financial Statements

 

REALTY INCOME CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

March 31, 2015 and December 31, 2014

(dollars in thousands, except per share data)

 

 

 

2015

 

2014

 

ASSETS

 

(unaudited)

 

 

 

Real estate, at cost:

 

 

 

 

 

Land

 

$

3,081,468

 

$

3,046,372

 

Buildings and improvements

 

8,221,599

 

8,107,199

 

Total real estate, at cost

 

11,303,067

 

11,153,571

 

Less accumulated depreciation and amortization

 

(1,459,320

)

(1,386,871

)

Net real estate held for investment

 

9,843,747

 

9,766,700

 

Real estate held for sale, net

 

9,394

 

14,840

 

Net real estate

 

9,853,141

 

9,781,540

 

Cash and cash equivalents

 

12,190

 

3,852

 

Accounts receivable, net

 

66,831

 

64,386

 

Acquired lease intangible assets, net

 

1,056,845

 

1,039,724

 

Goodwill

 

15,425

 

15,470

 

Other assets, net

 

87,721

 

107,650

 

Total assets

 

$

11,092,153

 

$

11,012,622

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Distributions payable

 

$

45,466

 

$

43,675

 

Accounts payable and accrued expenses

 

77,594

 

123,287

 

Acquired lease intangible liabilities, net

 

228,191

 

220,469

 

Other liabilities

 

41,404

 

53,145

 

Line of credit payable

 

370,000

 

223,000

 

Term loan

 

70,000

 

70,000

 

Mortgages payable, net

 

799,318

 

852,575

 

Notes payable, net

 

3,785,718

 

3,785,372

 

Total liabilities

 

5,417,691

 

5,371,523

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock and paid in capital, par value $0.01 per share, 69,900,000 shares authorized, 16,350,000 shares issued and outstanding as of March 31, 2015 and December 31, 2014

 

395,378

 

395,378

 

Common stock and paid in capital, par value $0.01 per share, 370,100,000 shares authorized, 227,031,104 shares issued and outstanding as of March 31, 2015 and 224,881,192 shares issued and outstanding at December 31, 2014

 

6,569,610

 

6,464,987

 

Distributions in excess of net income

 

(1,314,952

)

(1,246,964

)

Total stockholders’ equity

 

5,650,036

 

5,613,401

 

Noncontrolling interests

 

24,426

 

27,698

 

Total equity

 

5,674,462

 

5,641,099

 

Total liabilities and equity

 

$

11,092,153

 

$

11,012,622

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

-2-



Table of Contents

 

REALTY INCOME CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

 

For the three months ended March 31, 2015 and 2014

(dollars in thousands, except per share data) (unaudited)

 

 

 

 

 

 

2015

 

2014

 

REVENUE

 

 

 

 

 

Rental

 

$

235,122

 

$

214,122

 

Tenant reimbursements

 

9,963

 

6,427

 

Other

 

1,782

 

1,023

 

Total revenue

 

246,867

 

221,572

 

 

 

 

 

 

 

EXPENSES

 

 

 

 

 

Depreciation and amortization

 

98,037

 

89,970

 

Interest

 

58,468

 

51,720

 

General and administrative

 

12,862

 

12,886

 

Property (including reimbursable)

 

13,976

 

10,577

 

Income taxes

 

1,074

 

1,091

 

Provisions for impairment

 

2,087

 

1,683

 

Total expenses

 

186,504

 

167,927

 

Gain on sales of real estate

 

7,218

 

1,271

 

Income from continuing operations

 

67,581

 

54,916

 

Income from discontinued operations

 

-

 

3,077

 

Net income

 

67,581

 

57,993

 

Net income attributable to noncontrolling interests

 

(317

)

(332

)

Net income attributable to the Company

 

67,264

 

57,661

 

Preferred stock dividends

 

(6,770

)

(10,482

)

Net income available to common stockholders

 

$

60,494

 

$

47,179

 

 

 

 

 

 

 

Amounts available to common stockholders per common share:

 

 

 

 

 

Income from continuing operations, basic and diluted

 

$

0.27

 

$

0.21

 

Net income, basic and diluted

 

$

0.27

 

$

0.23

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

Basic

 

225,346,407

 

207,003,950

 

Diluted

 

225,825,854

 

207,324,363

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

-3-



Table of Contents

 

REALTY INCOME CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the three months ended March 31, 2015 and 2014

(dollars in thousands) (unaudited)

 

 

 

2015

 

2014

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

67,581

 

$

57,993

 

Adjustments to net income:

 

 

 

 

 

Depreciation and amortization

 

98,037

 

89,970

 

Income from discontinued operations

 

-

 

(3,077

)

Amortization of share-based compensation

 

2,552

 

2,697

 

Non-cash rental adjustments

 

(2,449

)

(1,942

)

Amortization of net premiums on mortgages payable

 

(1,962

)

(2,385

)

Amortization of deferred financing costs

 

2,228

 

2,585

 

Gain on sales of real estate

 

(7,218

)

(1,271

)

Provisions for impairment on real estate

 

2,087

 

1,683

 

Cash provided by discontinued operations

 

-

 

1,290

 

Change in assets and liabilities

 

 

 

 

 

Accounts receivable and other assets

 

892

 

9,600

 

Accounts payable, accrued expenses and other liabilities

 

(43,896

)

(42,947

)

Net cash provided by operating activities

 

117,852

 

114,196

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Investment in real estate

 

(202,781

)

(603,980

)

Improvements to real estate, including leasing costs

 

(1,345

)

(1,369

)

Proceeds from sales of real estate:

 

 

 

 

 

Continuing operations

 

22,274

 

5,772

 

Discontinued operations

 

-

 

6,918

 

Restricted escrow deposits for Section 1031 tax-deferred exchanges and pending acquisitions

 

18,083

 

(460

)

Net cash used in investing activities

 

(163,769

)

(593,119

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Cash distributions to common stockholders

 

(126,682

)

(113,414

)

Cash dividends to preferred stockholders

 

(6,770

)

(10,482

)

Borrowings on line of credit

 

282,000

 

732,800

 

Payments on line of credit

 

(135,000

)

(120,700

)

Principal payments on mortgages payable

 

(51,296

)

(1,797

)

Redemption of preferred units

 

(6,750

)

-

 

Distributions to noncontrolling interests

 

(428

)

(466

)

Proceeds from dividend reinvestment and stock purchase plan, net

 

102,162

 

2,126

 

Other items, including shares withheld upon vesting

 

(2,981

)

(5,259

)

Net cash provided by financing activities

 

54,255

 

482,808

 

Net increase in cash and cash equivalents

 

8,338

 

3,885

 

Cash and cash equivalents, beginning of period

 

3,852

 

10,257

 

Cash and cash equivalents, end of period

 

$

12,190

 

$

14,142

 

 

For supplemental disclosures, see note 16.

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

-4-



Table of Contents

 

REALTY INCOME CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2015

(unaudited)

 

1.                                     Management Statement

 

The consolidated financial statements of Realty Income Corporation (“Realty Income”, the “Company”, “we”, “our” or “us”) were prepared from our books and records without audit and include all adjustments (consisting of only normal recurring accruals) necessary to present a fair statement of results for the interim periods presented. Readers of this quarterly report should refer to our audited consolidated financial statements for the year ended December 31, 2014, which are included in our 2014 Annual Report on Form 10-K, as certain disclosures that would substantially duplicate those contained in the audited financial statements have not been included in this report.

 

At March 31, 2015, we owned 4,378 properties, located in 49 states and Puerto Rico, containing over 71.6 million leasable square feet.

 

2.                  Summary of Significant Accounting Policies and Procedures and Recent Accounting Pronouncements

 

A.  The accompanying consolidated financial statements include the accounts of Realty Income and other entities for which we make operating and financial decisions (i.e., control), after elimination of all material intercompany balances and transactions.  We consolidate entities that we control and record a noncontrolling interest for the portion that we do not own.  Noncontrolling interest that was created or assumed as part of a business combination was recognized at fair value as of the date of the transaction (see note 9).  We have no unconsolidated investments.

 

B.  We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended. We believe we have qualified and continue to qualify as a REIT. Under the REIT operating structure, we are permitted to deduct dividends paid to our stockholders in determining our taxable income.  Assuming our dividends equal or exceed our net income, we generally will not be required to pay federal corporate income taxes on such income. Accordingly, no provision has been made for federal income taxes in the accompanying consolidated financial statements, except for federal income taxes of our taxable REIT subsidiaries. The income taxes recorded on our consolidated statements of income represent amounts paid by Realty Income for city and state income and franchise taxes.

 

C.  We recognize an allowance for doubtful accounts relating to accounts receivable for amounts deemed uncollectible. We consider tenant specific issues, such as financial stability and ability to pay rent, when determining collectability of accounts receivable and appropriate allowances to record.  The allowance for doubtful accounts was $409,000 at March 31, 2015 and $765,000 at December 31, 2014.

 

D.  We assign a portion of goodwill to our applicable property sales, which results in a reduction of the carrying amount of our goodwill. In order to allocate goodwill to the carrying amount of properties that we sell, we utilize a relative fair value approach based on the original methodology for assigning goodwill.  As we sell properties, our goodwill will likely continue to gradually decrease over time.

 

E.  In April 2015, the Financial Accounting Standards Board, or FASB, issued ASU 2015-03, which amends Topic 835, Other Presentation Matters. The amendments in the ASU require that debt issuance costs be reported on the balance sheet as a direct reduction of the face amount of the debt instrument they relate to, and should not be classified as a deferred charge, as was previously required under the Accounting Standards Codification.  ASU 2015-03 is effective, on a retrospective basis, for interim and annual periods beginning after December 15, 2015; early adoption is permitted.  We do not expect the adoption of this ASU to have a material impact on our consolidated financial statements.

 

-5-



Table of Contents

 

3.                                     Supplemental Detail for Certain Components of Consolidated Balance Sheets

 

A. Acquired lease intangible assets, net, consist of the following

 

March 31,

 

December 31,

 

    (dollars in thousands) at:

 

2015

 

2014

 

Acquired in-place leases

 

$

1,021,247

 

$    1,005,244

 

Accumulated amortization of acquired in-place leases

 

(198,976

)

(177,722

)

Acquired above-market leases

 

279,650

 

252,581

 

Accumulated amortization of acquired above-market leases

 

(45,076

)

(40,379

)

 

 

$

1,056,845

 

$    1,039,724

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

B. Other assets, net, consist of the following (dollars in thousands) at:

 

2015

 

2014

 

Deferred financing costs, net

 

$

22,295

 

$          23,274

 

Restricted escrow deposits

 

18,300

 

36,540

 

Notes receivable issued in connection with property sales

 

18,243

 

18,342

 

Prepaid expenses

 

15,166

 

14,137

 

Impounds related to mortgages payable

 

4,868

 

5,789

 

Credit facility origination costs, net

 

3,403

 

4,171

 

Corporate assets, net

 

2,492

 

2,600

 

Other items

 

2,954

 

2,797

 

 

 

$

87,721

 

$        107,650

 

 

 

 

 

 

 

C. Distributions payable consist of the following declared

 

March 31,

 

December 31,

 

    distributions (dollars in thousands) at:

 

2015

 

2014

 

Common stock distributions

 

$

43,069

 

$          41,268

 

Preferred stock dividends

 

2,257

 

2,257

 

Noncontrolling interests distributions

 

140

 

150

 

 

 

$

45,466

 

$          43,675

 

 

 

 

 

 

 

D. Accounts payable and accrued expenses consist of the

 

March 31,

 

December 31,

 

    following (dollars in thousands) at:

 

2015

 

2014

 

Notes payable - interest payable

 

$

34,617

 

$          63,919

 

Accrued costs on properties under development

 

11,498

 

18,011

 

Property taxes payable

 

9,641

 

11,634

 

Other items

 

21,838

 

29,723

 

 

 

$

77,594

 

$        123,287

 

 

 

 

 

 

 

E. Acquired lease intangible liabilities, net, consist of the

 

March 31,

 

December 31,

 

    following (dollars in thousands) at:

 

2015

 

2014

 

Acquired below-market leases

 

$

254,381

 

$        243,025

 

Accumulated amortization of acquired below-market leases

 

(26,190

)

(22,556

)

 

 

$

228,191

 

$        220,469

 

 

 

 

 

 

 

F. Other liabilities consist of the following

 

March 31,

 

December 31,

 

    (dollars in thousands) at:

 

2015

 

2014

 

Rent received in advance

 

$

30,933

 

$          36,122

 

Security deposits

 

5,996

 

5,876

 

Capital lease obligation

 

4,475

 

4,397

 

Preferred units issued upon entity acquisition

 

-

 

6,750

 

 

 

$

41,404

 

$          53,145

 

 

-6-



Table of Contents

 

4.         Investments in Real Estate

 

We acquire land, buildings and improvements necessary for the successful operations of commercial tenants.

 

A.           Acquisitions during the First Three Months of 2015 and 2014

During the first three months of 2015, we invested $209.9 million in 83 new properties and properties under development or expansion with an initial weighted average contractual lease rate of 6.9%. The 83 new properties and properties under development or expansion are located in 24 states, will contain approximately 1.6 million leasable square feet, and are 100% leased with a weighted average lease term of 15.5 years. The tenants occupying the new properties operate in 12 industries and the property types consist of 74.2% retail, and 25.8% industrial and distribution, based on rental revenue.  None of our investments during 2015 caused any one tenant to be 10% or more of our total assets at March 31, 2015.

 

The $209.9 million invested during the first three months of 2015 was allocated as follows: $39.8 million to land, $121.2 million to buildings and improvements, $41.6 million to intangible assets related to leases, $14.1 million to other assets, net, and $6.8 million to intangible liabilities related to leases and other assumed liabilities.  There was no contingent consideration associated with these acquisitions.

 

The properties acquired during the first three months of 2015 generated total revenues of $1.5 million and income from continuing operations of $712,000.

 

The purchase price allocation for $197.7 million of the $209.9 million we invested in during the first three months of 2015 is based on a preliminary measurement of fair value that is subject to change.  The allocation for these properties represents our current best estimate of fair value and we expect to finalize the valuations and complete the purchase price allocations in 2015. During the first three months of 2015, we finalized the purchase price allocations for $147.1 million invested in the fourth quarter of 2014.  There were no material changes to our consolidated balance sheets or income statements as a result of these purchase price allocation adjustments.

 

In comparison, during the first three months of 2014, we invested $656.7 million in 337 new properties and properties under development or expansion with an initial weighted average contractual lease rate of 7.0%. The 337 new properties and properties under development or expansion, were located in 35 states, contained over 4.5 million leasable square feet and were 100% leased with a weighted average lease term of 14.2 years. The tenants occupying the new properties operate in 15 industries and the property types consist of 87.6% retail, 7.8% industrial and distribution, and 4.6% office, based on rental revenue.

 

The $656.7 million invested during the first three months of 2014 was allocated as follows: $132.2 million to land, $455.3 million to buildings and improvements, $74.0 million to intangible assets related to leases, $901,000 to other assets, net, and $8.5 million to intangible liabilities related to leases and other assumed liabilities. We also recorded mortgage discounts of $2.8 million associated with the $45.9 million of mortgages acquired during the first three months of 2014.  There was no contingent consideration associated with these acquisitions.

 

The properties acquired during the first three months of 2014 contributed total revenues of $7.9 million and income from continuing operations of $3.2 million for the three months ended March 31, 2014.

 

The estimated initial weighted average contractual lease rate for a property is generally computed as estimated contractual net operating income, which, in the case of a net leased property, is equal to the aggregate base rent for the first full year of each lease, divided by the total cost of the property.  Since it is possible that a tenant could default on the payment of contractual rent, we cannot provide assurance that the actual return on the funds invested will remain at the percentages listed above.

 

In the case of a property under development or expansion, the contractual lease rate is generally fixed such that rent varies based on the actual total investment in order to provide a fixed rate of return.  When the lease does not provide for a fixed rate of return on a property under development or expansion, the estimated initial weighted average contractual lease rate is computed as follows: estimated net operating income (determined by the lease) for the first full year of each lease, divided by our projected total investment in the property, including land, construction and capitalized interest costs. Of the $209.9 million we invested during the first three months of 2015, $15.3 million was invested in 25 properties under development or expansion with an estimated initial weighted average contractual lease rate of 9.0%.  Of the $656.7 million we invested during the first three months of 2014, $13.4 million was invested in 13 properties under development or expansion with an estimated initial weighted average contractual lease rate of 8.4%.

 

-7-



Table of Contents

 

B.           Acquisition Transaction Costs

Acquisition transaction costs of $94,000 and $454,000 were recorded to general and administrative expense on our consolidated statements of income during the first three months of 2015 and 2014, respectively.

 

C.           Investments in Existing Properties

During the first three months of 2015, we capitalized costs of $1.3 million on existing properties in our portfolio, consisting of $313,000 for re-leasing costs and $1.0 million for building and tenant improvements.  In comparison, during the first three months of 2014, we capitalized costs of $1.4 million on existing properties in our portfolio, consisting of $192,000 for re-leasing costs and $1.2 million for building and tenant improvements.

 

D.           Properties with Existing Leases

Of the $209.9 million we invested during the first three months of 2015, approximately $114.2 million was used to acquire 14 properties with existing leases.  In comparison, of the $656.7 million we invested in the first three months of 2014, approximately $403.8 million was used to acquire 90 properties with existing leases. The value of the in-place and above-market leases is recorded to acquired lease intangible assets, net on our consolidated balance sheets, and the value of the below-market leases is recorded to acquired lease intangible liabilities, net on our consolidated balance sheets.  The values recorded to all of these intangible values for properties acquired during the first quarter of 2015 are based on a preliminary measurement of fair value that is subject to change.

 

The values of the in-place leases are amortized as depreciation and amortization expense.  The amounts amortized to expense for all of our in-place leases, for the first three months of 2015 and 2014, were $21.6 million and $20.1 million, respectively.

 

The values of the above-market and below-market leases are amortized over the term of the respective leases, including any bargain renewal options, as an adjustment to rental revenue on our consolidated statements of income. The amounts amortized as a net decrease to rental revenue for capitalized above-market and below-market leases for the first three months of 2015 and 2014 were $1.7 million and $2.0 million, respectively.  If a lease were to be terminated prior to its stated expiration, all unamortized amounts relating to that lease would be recorded to revenue or expense as appropriate.

 

The following table presents the estimated impact during the next five years and thereafter related to the amortization of the acquired above-market and below-market lease intangibles and the amortization of the in-place lease intangibles for properties held for investment at March 31, 2015 (in thousands):

 

 

Net increase

 

Increase to

 

 

 

(decrease) to

 

amortization

 

 

 

rental revenue

 

expense

 

2015

 

$

(5,889

)

$

65,083

 

2016

 

(7,864

)

86,533

 

2017

 

(7,809

)

85,333

 

2018

 

(7,549

)

82,889

 

2019

 

(6,563

)

72,831

 

Thereafter

 

29,291

 

429,602

 

 

 

 

 

 

 

Totals

 

$

(6,383

)

$

822,271

 

 

5.                                     Credit Facility

 

We have a $1.5 billion unsecured acquisition credit facility with an initial term that expires in May 2016 and includes, at our election, a one-year extension option. Under this credit facility, our current investment grade credit ratings provide for financing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 1.075% with a facility commitment fee of 0.175%, for all-in drawn pricing of 1.25% over LIBOR. The borrowing rate is not subject to an interest rate floor or ceiling. We also have other interest rate options available to us under this credit facility. Our credit facility is unsecured and, accordingly, we have not pledged any assets as collateral for this obligation.

 

-8-



Table of Contents

 

At March 31, 2015, credit facility origination costs of $3.4 million are included in other assets, net, on our consolidated balance sheet.  These costs are being amortized over the remaining term of our $1.5 billion credit facility.

 

At March 31, 2015, we had a borrowing capacity of $1.13 billion available on our credit facility (subject to customary conditions to borrowing) and an outstanding balance of $370.0 million, as compared to an outstanding balance of $223.0 million at December 31, 2014.

 

The weighted average interest rate on outstanding borrowings under our credit facilities was 1.2% during the first three months of 2015 and 2014. At March 31, 2015, the effective interest rate was 1.2%.  Our current credit facility is subject to various leverage and interest coverage ratio limitations, and at March 31, 2015, we remain in compliance with these covenants.  We regularly review our credit facility and may seek to extend, renew or replace our credit facility, to the extent we deem appropriate.

 

6.     Mortgages Payable

 

During the first three months of 2015, we made $51.3 million in principal payments, including the repayment of three mortgages in full for $49.4 million.  No mortgages were assumed during the first three months of 2015.

 

During the first three months of 2014, we made $1.8 million in principal payments and assumed mortgages totaling $45.9 million, excluding net discounts.  The mortgages are secured by the properties on which the debt was placed.  We expect to pay off the mortgages as soon as prepayment penalties make it economically feasible to do so.

 

During the first three months of 2014, aggregate net discounts totaling $2.8 million were recorded upon assumption of mortgages with below-market interest rates. Amortization of our net premiums is recorded as a reduction to interest expense over the remaining term of the respective mortgages, using a method that approximates the effective-interest method.

 

These mortgages contain customary covenants, such as limiting our ability to further mortgage each applicable property or to discontinue insurance coverage without the prior consent of the lender. At March 31, 2015, we remain in compliance with these covenants.

 

We did not incur any deferred financing costs on our mortgages assumed in 2014. The balance of our deferred financing costs, which are classified as part of other assets, net, on our consolidated balance sheets, was $750,000 at March 31, 2015 and $827,000 at December 31, 2014. These costs are being amortized over the remaining term of each mortgage.

 

The following is a summary of all our mortgages payable as of March 31, 2015 and December 31, 2014, respectively (dollars in thousands):

 

 

 

 

Weighted

 

Weighted

 

Weighted

 

 

 

 

 

 

 

 

 

 

 

Average

 

Average

 

Average

 

 

 

 

 

 

 

 

 

 

 

Stated

 

Effective

 

Remaining

 

Remaining

 

Unamortized

 

Mortgage

 

 

 

Number of

 

Interest

 

Interest

 

Years Until

 

Principal

 

Premium

 

Payable

 

As Of

 

Properties(1)

 

Rate(2)

 

Rate(3)

 

Maturity

 

Balance

 

Balance, net

 

Balance

 

3/31/15

 

238

 

5.0%

 

4.0%

 

3.7

 

$     784,715

 

$         14,603

 

$       799,318

 

12/31/14

 

241

 

5.0%

 

4.0%

 

3.7

 

$     836,011

 

$         16,564

 

$       852,575

 

 

(1)    At March 31, 2015, there were 54 mortgages on the 238 properties, while at December 31, 2014, there were 57 mortgages on the 241 properties. The mortgages require monthly payments, with principal payments due at maturity. The mortgages are at fixed interest rates, except for four mortgages on 13 properties totaling $50.9 million at March 31, 2015, including net unamortized discounts. At December 31, 2014, five mortgages on 14 properties totaling $74.5 million, including net unamortized discounts, were at variable interest rates. All of these variable rate mortgages were acquired with arrangements which limit our exposure to interest rate risk.

(2)    Stated interest rates ranged from 2.0% to 6.9% at March 31, 2015 and December 31, 2014.

(3)    Effective interest rates ranged from 2.2% to 9.0% at March 31, 2015 and December 31, 2014.

 

 

-9-



Table of Contents

 

The following table summarizes the maturity of mortgages payable, excluding net premiums of $14.6 million, as of March 31, 2015 (dollars in millions):

 

Year of

 

 

 

Maturity

 

 

 

2015

 

$

68.4

 

2016

 

248.4

 

2017

 

142.5

 

2018

 

15.1

 

2019

 

26.0

 

Thereafter

 

284.3

 

Totals

 

$

784.7

 

 

7.                                     Term Loan

 

In January 2013, in conjunction with our acquisition of American Realty Capital Trust, Inc., or ARCT, we entered into a $70 million senior unsecured term loan maturing January 21, 2018.  Borrowing under the term loan bears interest at the current one month LIBOR, plus 1.2%.  In conjunction with this term loan, we also acquired an interest rate swap which essentially fixes our per annum interest rate on the term loan at 2.15%.  Deferred financing costs of $303,000 are being amortized over the remaining term of the term loan.  The net balance of these deferred financing costs, which was $172,000 at March 31, 2015, and $187,000 at December 31, 2014, is included in other assets, net on our consolidated balance sheets.

 

8.                                     Notes Payable

 

A.           General

 

Our senior unsecured notes and bonds consisted of the following, sorted by maturity date (dollars in millions):

 

 

 

March 31,

 

December 31,

 

 

 

2015

 

2014

 

5.5% notes, issued in November 2003 and due in November 2015

 

$

150

 

$

150

 

5.95% notes, issued in September 2006 and due in September 2016

 

275

 

275

 

5.375% notes, issued in September 2005 and due in September 2017

 

175

 

175

 

2.0% notes, issued in October 2012 and due in January 2018

 

350

 

350

 

6.75% notes, issued in September 2007 and due in August 2019

 

550

 

550

 

5.75% notes, issued in June 2010 and due in January 2021

 

250

 

250

 

3.25% notes, issued in October 2012 and due in October 2022

 

450

 

450

 

4.65% notes, issued in July 2013 and due in August 2023

 

750

 

750

 

3.875% notes, issued in June 2014 and due in July 2024

 

350

 

350

 

4.125% notes, issued in September 2014 and due in October 2026

 

250

 

250

 

5.875% bonds, $100 issued in March 2005 and $150 issued in

 

 

 

 

 

June 2011, both due in March 2035

 

250

 

250

 

Total principal amount

 

3,800

 

3,800

 

Unamortized original issuance discounts

 

(14

)

(15

)

 

 

$

3,786

 

$

3,785

 

 

The following table summarizes the maturity of our notes and bonds payable as of March 31, 2015, excluding unamortized original issuance discounts (dollars in millions):

 

 

 

Notes and

 

Year of Maturity

 

Bonds

 

2015

 

$

150

 

2016

 

275

 

2017

 

175

 

2018

 

350

 

2019

 

550

 

Thereafter

 

2,300

 

Totals

 

$

3,800

 

 

As of March 31, 2015, the weighted average interest rate on our notes and bonds payable was 4.8% and the weighted average remaining years until maturity was 7.0 years.

 

-10-



Table of Contents

 

9.         Noncontrolling Interests

 

In January 2013, we completed our acquisition of ARCT.  Equity issued as consideration for this transaction included common and preferred partnership units issued by Tau Operating Partnership, L.P., or Tau Operating Partnership, the consolidated subsidiary which owns properties acquired through the ARCT acquisition.  Realty Income and its subsidiaries hold a 99.3% interest in Tau Operating Partnership, and consolidate the entity.

 

In June 2013, we completed the acquisition of a portfolio of properties by issuing common partnership units in a newly formed entity, Realty Income, L.P.  The units were issued as consideration for the acquisition.  At March 31, 2015, the remaining units from this issuance represent a 1.7% ownership in Realty Income, L.P.  Realty Income holds the remaining 98.3% interests in this entity, and consolidates the entity.

 

A.         Neither of the common partnership units have voting rights. Both common partnership units are entitled to monthly distributions equal to the amount paid to common stockholders of Realty Income, and are redeemable in cash or Realty Income common stock, at our option, and at a conversion ratio of one to one, subject to certain exceptions.  Noncontrolling interests with redemption provisions that permit the issuer to settle in either cash or common stock, at the option of the issuer, were evaluated to determine whether temporary or permanent equity classification on the balance sheet was appropriate.  We determined that the units meet the requirements to qualify for presentation as permanent equity.

 

The following table represents the change in the carrying value of all noncontrolling interests through March 31, 2015 (dollars in thousands):

 

 

 

Tau Operating

 

Realty Income, L.P.

 

 

 

 

 

 

Partnership units(1)

 

units(2)

 

Total

 

Carrying value at December 31, 2014

 

 

$

13,067

 

$

14,631

 

$

27,698

 

Reallocation of equity

 

 

836

 

(1,887

)

(1,051

)

Redemptions

 

 

-

 

(2,120

)

(2,120

)

Distributions

 

 

(180

)

(238

)

(418

)

Allocation of net income

 

 

73

 

244

 

317

 

Carrying value at March 31, 2015

 

 

$

13,796

 

$

10,630

 

$

24,426

 

 

 

 

 

 

 

 

 

 

 

 

 

Tau Operating

 

Realty Income, L.P.

 

 

 

 

 

 

Partnership units(1)

 

units(2)

 

Total

 

Carrying value at December 31, 2013

 

 

$

13,489

 

$

22,422

 

$

35,911

 

Reallocation of equity

 

 

-

 

(6,647

)

(6,647

)

Redemptions

 

 

-

 

(1,032

)

(1,032

)

Distributions

 

 

(695

)

(1,144

)

(1,839

)

Allocation of net income

 

 

273

 

1,032

 

1,305

 

Carrying value at December 31, 2014

 

 

$

13,067

 

$

14,631

 

$

27,698

 

 

(1)       317,022 Tau Operating Partnership units were issued on January 22, 2013 and remained outstanding as of March 31, 2015 and December 31, 2014.

(2)       534,546 Realty Income, L.P. units were issued on June 27, 2013, 499,546 units were outstanding as of December 31, 2014 and 419,546 remain outstanding as of March 31, 2015.

 

During the first three months of 2015, we recorded net equity reclassification adjustments of $1.1 million between noncontrolling interests and additional paid in capital to adjust the carrying value of noncontrolling interests to be in-line with their equity ownership interests in the entities. During the first three months of 2014, we recorded an equity reclassification adjustment of $6.6 million between noncontrolling interests and additional paid in capital to adjust the carrying value of the Realty Income, L.P. noncontrolling interests to be in-line with their equity ownership interest in the entity.

 

B.         The Tau Operating Partnership preferred units were recorded at fair value as of the date of acquisition.  Since they were redeemable at a fixed price on a determinable date, we initially classified them in other liabilities on our consolidated balance sheets.  Payments on these preferred units were made monthly at a rate of 2% per annum and were included in interest expense.  As of December 31, 2014, the preferred units had a carrying value of $6.75 million.  In January 2015, we redeemed all 6,750 Tau Operating Partnership preferred units for $1,000 per unit, plus accrued and unpaid distributions.

 

-11-



Table of Contents

 

10.        Fair Value of Financial Instruments

 

Fair value is defined as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The disclosure for assets and liabilities measured at fair value requires allocation to a three-level valuation hierarchy. This valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. Categorization within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

We believe that the carrying values reflected in our consolidated balance sheets reasonably approximate the fair values for cash and cash equivalents, accounts receivable, escrow deposits, loans receivable, line of credit payable, term loan and all other liabilities, due to their short-term nature or interest rates and terms that are consistent with market, except for our notes receivable issued in connection with property sales, mortgages payable and our senior notes and bonds payable, which are disclosed below (dollars in millions):

 

 

Carrying value per

 

Estimated fair

At March 31, 2015

 

balance sheet

 

value

Notes receivable issued in connection with property sales

 

$

18.2

 

$

20.1

Mortgages payable assumed in connection with acquisitions, net

 

799.3

 

809.8

Notes and bonds payable, net of unamortized original issuance discounts

 

3,785.7

 

4,121.5

 

 

 

 

 

 

 

Carrying value per

 

Estimated fair

At December 31, 2014

 

balance sheet

 

value

Notes receivable issued in connection with property sales

 

$

18.3

 

$

20.1

Mortgages payable assumed in connection with acquisitions, net

 

852.6

 

857.9

Notes and bonds payable, net of unamortized original issuance discounts

 

3,785.4

 

4,092.8

 

The estimated fair values of our notes receivable issued in connection with property sales and our mortgages payable have been calculated by discounting the future cash flows using an interest rate based upon the relevant Treasury yield curve, plus an applicable credit-adjusted spread.  Because this methodology includes unobservable inputs that reflect our own internal assumptions and calculations, the measurement of estimated fair values related to our notes receivable and mortgages payable is categorized as level three on the three-level valuation hierarchy.

 

The estimated fair values of our senior notes and bonds payable are based upon indicative market prices and recent trading activity of our senior notes and bonds payable. Because this methodology includes inputs that are less observable by the public and are not necessarily reflected in active markets, the measurement of the estimated fair values, related to our notes and bonds payable, is categorized as level two on the three-level valuation hierarchy.

 

11.        Gain on Sales of Real Estate

 

During the first three months of 2015, we sold nine investment properties for $22.3 million, which resulted in a gain of $7.2 million.  The results of operations for these properties are presented within continuing operations.

 

During the first three months of 2014, Realty Income sold 11 investment properties for $12.7 million, which resulted in a gain of $3.9 million. Only the results of operations specifically related to the properties classified as held for sale at December 31, 2013 and sold during the first three months of 2014 have been reclassified as discontinued operations, which was $2.6 million.

 

During the first three months of 2015, Crest Net Lease, Inc., or Crest, did not sell any properties.  During the first three months of 2014, Crest sold one property for $820,000, which did not result in a gain. The results of operations for this property were reclassified as discontinued operations.

 

-12-



Table of Contents

 

12.        Discontinued Operations

 

During the first quarter of 2014, the Financial Accounting Standards Board issued guidance that changed the definition of discontinued operations by limiting discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have, or will have, a major effect on an entity’s operations and financial results.  We early adopted the requirements of this accounting pronouncement in the first quarter of 2014.

 

Starting with the first quarter of 2014, the results of operations for all qualifying disposals and properties classified as held for sale that were not previously reported in discontinued operations in our 2013 Annual Report on Form 10-K are presented within income from continuing operations on our consolidated statements of income.  Prior to the date of adoption of ASU 2014-08, we reported, in discontinued operations, the results of operations of properties that had either been disposed of or classified as held for sale in financial statements issued.  For the three months ended March 31, 2014, we recorded income from discontinued operations of $3.1 million, or $0.01 per common share, basic and diluted.

 

13.        Impairments

 

We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. A provision is made for impairment if estimated future operating cash flows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value of the property. Key factors that we estimate in this analysis include projected rental rates, estimated holding periods, capital expenditures and property sales capitalization rates. If a property is classified as held for sale, it is carried at the lower of carrying cost or estimated fair value, less estimated cost to sell, and depreciation of the property ceases.

 

For the first three months of 2015, we recorded total provisions for impairment of $2.1 million on the following properties in the restaurant-casual dining industry: one sold property, one property classified as held for sale, and one property disposed of other than by sale.  For the first three months of 2014, we recorded total provisions for impairment of $1.7 million on four sold properties in the following industries: one in the consumer electronics industry, one in the home furnishings industry, and two in the restaurant-casual dining industry.  These properties were not previously classified as held for sale in financial statements issued prior to the date of adoption of ASU 2014-08; accordingly, the provisions for impairment are included in income from continuing operations on our consolidated statement of income for the three months ended March 31, 2015 and March 31, 2014, respectively.

 

14.        Distributions Paid and Payable

 

A.                       Common Stock

We pay monthly distributions to our common stockholders.  The following is a summary of monthly distributions paid per common share for the first three months of 2015 and 2014:

 

Month

 

2015

 

2014

January

 

$

0.1834167

 

$

0.1821667

February

 

0.1890000

 

0.1821667

March

 

0.1890000

 

0.1821667

 

 

 

 

 

 

 

 

 

 

Total

 

$

0.5614167

 

$

0.5465001

 

At March 31, 2015, a distribution of $0.1895 per common share was payable and was paid in April 2015.

 

B.         Class E Preferred Stock

Prior to the redemption of the Class E preferred stock in October 2014, dividends of $0.140625 per share were paid monthly in arrears on the Class E preferred stock.  During the first three months of 2014, we paid three monthly dividends to holders of our Class E preferred stock totaling $0.421875 per share, or $3.7 million.

 

C.         Class F Preferred Stock

Dividends of $0.138021 per share are paid monthly in arrears on the Class F preferred stock.  During each of the first three months of 2015 and 2014, we paid three monthly dividends to holders of our Class F preferred stock totaling $0.414063 per share, or $6.8 million, and at March 31, 2015, a monthly dividend of $0.138021 per share was payable and was paid in April 2015.

 

-13-



Table of Contents

 

15.   Net Income Per Common Share

 

Basic net income per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during each period. Diluted net income per common share is computed by dividing net income available to common stockholders, plus income attributable to dilutive shares and convertible common units, for the period by the weighted average number of common shares that would have been outstanding assuming the issuance of common shares for all potentially dilutive common shares outstanding during the reporting period.

 

The following is a reconciliation of the denominator of the basic net income per common share computation to the denominator of the diluted net income per common share computation.

 

 

 

             Three months ended

 

 

 

                   March 31,

 

 

 

2015

 

2014

 

Weighted average shares used for the basic net income

 

 

 

 

 

per share computation

 

225,346,407

 

207,003,950

 

Incremental shares from share-based compensation

 

162,425

 

3,391

 

Weighted average partnership common units convertible

 

 

 

 

 

to common shares that were dilutive

 

317,022

 

317,022

 

Weighted average shares used for diluted net

 

 

 

 

 

income per share computation

 

225,825,854

 

207,324,363

 

Unvested shares from share-based compensation that

 

 

 

 

 

were anti-dilutive

 

111,338

 

194,933

 

Weighted average partnership common units convertible

 

 

 

 

 

to common shares that were anti-dilutive

 

440,546

 

534,546

 

 

16.        Supplemental Disclosures of Cash Flow Information

 

Cash paid for interest was $85.9 million in the first three months of 2015 and $79.9 million in the first three months of 2014.

 

Interest capitalized to properties under development was $94,000 in the first three months of 2015 and $95,000 in the first three months of 2014.

 

Cash paid for income taxes was $1.8 million in the first three months of 2015 and $942,000 in the first three months of 2014.

 

The following non-cash activities are included in the accompanying consolidated financial statements:

 

A.     See note 13 for a discussion of impairments recorded by Realty Income for the first three months of 2015 and 2014.

 

B.     During the first three months of 2014, we assumed mortgages payable to third-party lenders of $45.9 million, recorded $2.8 million of net discounts, and recorded $901,000 of interest rate swap value to other assets, net, related to property acquisitions.

 

C.     During the first three months of 2014, we applied $48.9 million of loans receivable to the purchase price of five acquired properties.

 

D.    Accrued costs on properties under development resulted in an increase of $7.1 million at March 31, 2014.

 

-14-



Table of Contents

 

17.        Segment Information

 

We evaluate performance and make resource allocation decisions on an industry by industry basis. For financial reporting purposes, we have grouped our tenants into 48 activity segments. All of the properties are incorporated into one of the applicable segments. Because almost all of our leases require the tenant to pay operating expenses, rental revenue is the only component of segment profit and loss we measure.

 

-15-



Table of Contents

 

The following tables set forth certain information regarding the properties owned by us, classified according to the business of the respective tenants, as of March 31, 2015 (dollars in thousands):

 

 

 

March 31,

 

December 31,

Assets, as of:

 

2015

 

2014

Segment net real estate:

 

 

 

 

Apparel

 

$

187,016

 

$

188,387

Automotive service

 

131,420

 

119,684

Automotive tire services

 

252,785

 

254,857

Beverages

 

300,932

 

302,001

Child care

 

53,647

 

54,523

Convenience stores

 

746,209

 

752,047

Dollar stores

 

1,156,416

 

1,165,560

Drug stores

 

1,057,256

 

1,036,697

Financial services

 

260,145

 

262,095

Grocery stores

 

336,052

 

338,624

Health and fitness

 

541,941

 

546,583

Health care

 

224,982

 

227,084

Home improvement

 

229,131

 

226,577

Restaurants-casual dining

 

444,247

 

450,337

Restaurants-quick service

 

376,562

 

336,753

Theaters

 

375,636

 

375,982

Transportation services

 

659,753

 

661,053

Wholesale club

 

462,317

 

465,569

30 other non-reportable segments

 

2,056,694

 

2,017,127

Total segment net real estate

 

9,853,141

 

9,781,540

 

 

 

 

 

Intangible assets:

 

 

 

 

Apparel

 

51,580

 

52,680

Automotive service

 

20,111

 

2,909

Automotive tire services

 

14,453

 

14,871

Beverages

 

2,732

 

2,797

Convenience stores

 

17,161

 

17,535

Dollar stores

 

57,352

 

58,691

Drug stores

 

197,445

 

194,905

Financial services

 

38,330

 

39,564

Grocery stores

 

45,719

 

46,729

Health and fitness

 

65,189

 

66,460

Health care

 

33,750

 

35,017

Home improvement

 

36,946

 

35,726

Restaurants-casual dining

 

10,335

 

10,649

Restaurants-quick service

 

21,623

 

16,415

Theaters

 

20,561

 

21,601

Transportation services

 

97,902

 

101,040

Wholesale club

 

38,834

 

39,707

Other non-reportable segments

 

286,822

 

282,428

 

 

 

 

 

Goodwill:

 

 

 

 

Automotive service

 

448

 

452

Automotive tire services

 

865

 

865

Child care

 

5,064

 

5,095

Convenience stores

 

2,023

 

2,023

Restaurants-casual dining

 

2,269

 

2,279

Restaurants-quick service

 

1,085

 

1,085

Other non-reportable segments

 

3,671

 

3,671

Other corporate assets

 

166,742

 

175,888

Total assets

 

$

11,092,153

 

$

11,012,622

 

-16-



Table of Contents

 

Revenue for the three months ended March 31,

 

2015

 

2014

 

Segment rental revenue:

 

 

 

 

 

Apparel

 

$

5,004

 

$

3,800

 

Automotive service

 

4,232

 

3,994

 

Automotive tire services

 

7,069

 

7,052

 

Beverages

 

6,328

 

6,253

 

Child care

 

5,019

 

4,988

 

Convenience stores

 

22,545

 

22,105

 

Dollar stores

 

21,947

 

19,523

 

Drug stores

 

22,568

 

20,264

 

Financial services

 

4,264

 

4,122

 

Grocery stores

 

7,283

 

5,891

 

Health and fitness

 

16,015

 

14,848

 

Health care

 

4,017

 

3,987

 

Home improvement

 

5,178

 

2,771

 

Restaurants-casual dining

 

9,506

 

9,757

 

Restaurants-quick service

 

10,395

 

8,729

 

Theaters

 

12,190

 

11,529

 

Transportation services

 

12,951

 

11,282

 

Wholesale club

 

9,341

 

8,751

 

30 other non-reportable segments

 

49,270

 

44,476

 

Total rental revenue

 

235,122

 

214,122

 

Tenant reimbursements

 

9,963

 

6,427

 

Other revenue

 

1,782

 

1,023

 

Total revenue

 

$

246,867

 

$

221,572

 

 

18.        Common Stock Incentive Plan

 

In 2012, our Board of Directors adopted and stockholders approved the Realty Income Corporation 2012 Incentive Award Plan, or the 2012 Plan, to enable us to motivate, attract and retain the services of directors, employees and consultants considered essential to our long-term success. The 2012 Plan offers our directors, employees and consultants an opportunity to own stock in Realty Income or rights that will reflect our growth, development and financial success. Under the terms of the 2012 plan, the aggregate number of shares of our common stock subject to options, restricted stock, stock appreciation rights, restricted stock units and other awards, will be no more than 3,985,734 shares. The 2012 Plan has a term of 10 years from the date it was adopted by our Board of Directors.

 

The amount of share-based compensation costs recognized in general and administrative expense on our consolidated statements of income was $2.6 million during the first three months of 2015 and $2.7 million during the first three months of 2014.

 

-17-



Table of Contents

 

A.   Restricted Stock

The following table summarizes our common stock grant activity under our 2012 Plan. Our outstanding restricted stock vests over periods ranging from immediately to five years.

 

 

 

For the three months ended

 

For the year ended

 

 

March 31, 2015

 

December 31, 2014

 

 

 

 

Weighted

 

 

 

Weighted

 

 

Number of

 

average

 

Number of

 

average

 

 

shares

 

price(1)

 

shares

 

price(1)

Outstanding nonvested

 

 

 

 

 

 

 

 

shares, beginning of year

 

527,176

 

$

29.02

 

722,263

 

$

23.37

Shares granted

 

123,585

 

$

51.86

 

262,655

 

$

39.87

Shares vested

 

(118,630

)

$

35.20

 

(440,348

)

$

36.88

Shares forfeited

 

(21,810

)

$

45.13

 

(17,394

)

$

39.07

Outstanding nonvested

 

 

 

 

 

 

 

 

shares, end of each period

 

510,321

 

$

36.07

 

527,176

 

$

29.02

 

 

 

 

 

 

 

 

 

(1) Grant date fair value.

 

 

 

 

 

 

 

 

 

During the first three months of 2015, we issued 123,585 shares of common stock under the 2012 Plan. These shares vest over a five year service period.  Not included in the table above are 10,269 restricted share units granted during the first three months of 2015 that vest over a five year service period and have the same economic rights as shares of restricted stock.

 

As of March 31, 2015, the remaining unamortized share-based compensation expense related to restricted stock totaled $18.4 million, which is being amortized on a straight-line basis over the service period of each applicable award.

 

Due to a historically low turnover rate, we do not estimate a forfeiture rate for our nonvested shares. Accordingly, unexpected forfeitures will lower share-based compensation expense during the applicable period. Under the terms of our 2012 Plan, we pay non-refundable dividends to the holders of our nonvested shares. Applicable accounting guidance requires that the dividends paid to holders of these nonvested shares be charged as compensation expense to the extent that they relate to nonvested shares that do not or are not expected to vest. However, since we do not estimate forfeitures given our historical trends, we did not record any compensation expense related to dividends paid in the first three months of 2015 or 2014.

 

B.    Performance Shares

During the first three month of 2015, and the year ended December 31, 2014, we granted performance share awards, as well as dividend equivalent rights.  The number of performance shares that vest is based on the achievement of the following performance goals:

 

2015 Performance Awards

 

 

 

Metrics

 

Weighting

 

Total shareholder return (“TSR”) relative to MSCI US REIT Index

 

50%

 

TSR relative to NAREIT Freestanding Index

 

20%

 

Dividend per share growth rate

 

20%

 

Debt-to-EBITDA ratio

 

10%

 

 

 

 

 

2014 Performance Awards

 

 

 

Metrics

 

Weighting

 

TSR relative to MSCI US REIT Index

 

60%

 

TSR relative to NAREIT Freestanding Index

 

20%

 

Debt-to-EBITDA ratio

 

20%

 

 

The performance shares are earned based on our performance, and vest 50% on the first and second January 1 after the end of the three year performance period, subject to continued service. The performance period for the 2014 performance awards began on January 1, 2014 and will end on December 31, 2016. The performance period for the 2015 performance awards began on January 1, 2015 and will end on December 31, 2017.

 

-18-



Table of Contents

 

The fair value of the performance shares was estimated on the date of grant using a Monte Carlo Simulation model. The following table summarizes our performance share grant activity:

 

 

 

For the three months ended

 

For the year ended

 

 

March 31, 2015

 

December 31, 2014

 

 

Number of

 

Weighted

 

Number of

 

Weighted

 

 

performance

 

average

 

performance

 

average

 

 

shares

 

price(1)

 

shares

 

price(1)

Outstanding nonvested

 

 

 

 

 

 

 

 

shares, beginning of year

 

59,405

 

$

41.46

 

-

 

$

-

Shares granted

 

55,716

 

$

52.78

 

71,705

 

$

41.46

Shares vested

 

-

 

$

-

 

(4,067

)

$

41.46

Shares forfeited

 

-

 

$

-

 

(8,233

)

$

41.46

Outstanding nonvested

 

 

 

 

 

 

 

 

shares, end of each period

 

115,121

 

$

46.94

 

59,405

 

$

41.46

 

 

 

 

 

 

 

 

 

(1) Grant date fair value.

 

 

 

 

 

 

 

 

 

As of March 31, 2015, the remaining share-based compensation expense related to the performance shares totaled $4.6 million.  The portion related to the market-based awards is being recognized on a straight-line basis over the service period, and the portion related to the performance-based awards is being recognized on a tranche-by-tranche basis over the service period.

 

19.        Dividend Reinvestment and Stock Purchase Plan

 

We have a Dividend Reinvestment and Stock Purchase Plan, or the DRSPP, to provide our common stockholders, as well as new investors, with a convenient and economical method of purchasing our common stock and reinvesting their distributions. The DRSPP also allows our current stockholders to buy additional shares of common stock by reinvesting all or a portion of their distributions. The DRSPP authorizes up to 11,000,000 common shares to be issued.  During the first three months of 2015, we issued 2,023,276 shares and raised approximately $102.2 million under the DRSPP.  During the first three months of 2014, we issued 55,870 shares and raised approximately $2.3 million under the DRSPP.  From the inception of the DRSPP through March 31, 2015, we have issued 7,114,784 shares and raised approximately $320.8 million.

 

In 2013, we revised our DRSPP to pay for a majority of the plan-related fees, which were previously paid by investors, and to institute a waiver approval process, allowing larger investors or institutions, per a formal approval process, to purchase shares at a small discount, if approved by us. During the first three months of 2015, we issued 1,980,994 shares and raised $100.0 million under the waiver approval process. These shares are included in the total activity for the first three months of 2015 noted in the preceding paragraph.

 

20.        Commitments and Contingencies

 

In the ordinary course of business, we are party to various legal actions which we believe are routine in nature and incidental to the operation of our business. We believe that the outcome of the proceedings will not have a material adverse effect upon our consolidated financial position or results of operations.

 

At March 31, 2015, we had commitments of $2.0 million for tenant improvements and leasing costs. In addition, as of March 31, 2015, we had committed $54.5 million under construction contracts, which is expected to be paid in the next twelve months.

 

21.        Subsequent Events

 

In April 2015, we declared the following dividends, which will be paid in May 2015:

 

·                  $0.1895 per share to our common stockholders and

·                  $0.138021 per share to our Class F preferred stockholders.

 

In April 2015, we issued 5,500,000 shares of common stock.  After underwriting discounts and other offering costs of $1.5 million, the net proceeds of $276.3 million were used to repay borrowings under our acquisition credit facility.

 

-19-



Table of Contents

 

Item 2.                  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q, including the documents incorporated by reference, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934, as amended. When used in this quarterly report, the words “estimated”, “anticipated”, “expect”, “believe”, “intend” and similar expressions are intended to identify forward-looking statements. Forward-looking statements include discussions of strategy, plans, or intentions of management. Forward-looking statements are subject to risks, uncertainties, and assumptions about Realty Income Corporation, including, among other things:

 

·                  Our anticipated growth strategies;

·                  Our intention to acquire additional properties and the timing of these acquisitions;

·                  Our intention to sell properties and the timing of these property sales;

·                  Our intention to re-lease vacant properties;

·                  Anticipated trends in our business, including trends in the market for long-term, net leases of freestanding, single-tenant properties; and

·                  Future expenditures for development projects.

 

Future events and actual results, financial and otherwise, may differ materially from the results discussed in the forward-looking statements. In particular, some of the factors that could cause actual results to differ materially are:

 

·                  Our continued qualification as a real estate investment trust;

·                  General business and economic conditions;

·                  Competition;

·                  Fluctuating interest rates;

·                  Access to debt and equity capital markets;

·                  Continued volatility and uncertainty in the credit markets and broader financial markets;

·                  Other risks inherent in the real estate business including tenant defaults, potential liability relating to environmental matters, illiquidity of real estate investments, and potential damages from natural disasters;

·                  Impairments in the value of our real estate assets;

·                  Changes in the tax laws of the United States of America;

·                  The outcome of any legal proceedings to which we are a party or which may occur in the future; and

·                  Acts of terrorism and war.

 

Additional factors that may cause risks and uncertainties include those discussed in the sections entitled “Business”, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K, for the fiscal year ended December 31, 2014.

 

Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date that this quarterly report was filed with the Securities and Exchange Commission, or SEC.  While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date of this quarterly report or to reflect the occurrence of unanticipated events. In light of these risks and uncertainties, the forward-looking events discussed in this quarterly report might not occur.

 

THE COMPANY

 

Realty Income, The Monthly Dividend Company®, is a S&P 500 real estate company with the primary business objective of generating dependable monthly cash dividends from a consistent and predictable level of cash flow from operations. Our monthly dividends are supported by the cash flow from our property portfolio. We have in-house acquisition, portfolio management, asset management, credit research, real estate research, legal, finance and accounting, information technology, and capital markets capabilities. Over the past 46 years, Realty Income has been acquiring and managing freestanding commercial properties that generate rental revenue under long-term net lease agreements.

 

-20-



Table of Contents

 

Realty Income (NYSE: O) was founded in 1969, and listed in 1994 on the New York Stock Exchange, or NYSE.  We elected to be taxed as a real estate investment trust, or REIT, requiring us to distribute dividends to our stockholders aggregating at least 90% of our taxable income (excluding net capital gains).

 

We seek to increase earnings and distributions to stockholders through active portfolio management, asset management and the acquisition of additional properties.

 

Generally, our portfolio and asset management efforts seek to achieve:

 

·                  Contractual rent increases on existing leases;

·                  Rent increases at the termination of existing leases, when market conditions permit;

·                  Active management of our property portfolio, including re-leasing vacant properties, and selectively selling properties, thereby mitigating our exposure to certain tenants and markets;

·                  Maximized asset-level returns on sold properties;

·                  Optimized value on existing portfolio by enhancing individual properties, pursuing alternative uses, and deriving ancillary revenue; and

·                  Investment opportunities in new asset classes for the portfolio.

 

At March 31, 2015, we owned a diversified portfolio:

 

·                  Of 4,378 properties;

·                  With an occupancy rate of 98.0%, or 4,292 properties leased and 86 properties available for lease;

·                  Leased to 236 different commercial tenants doing business in 47 separate industries;

·                  Located in 49 states and Puerto Rico;

·                  With over 71.6 million square feet of leasable space; and

·                  With an average leasable space per property of approximately 16,360 square feet, including approximately 11,250 square feet per retail property and 200,580 square feet per industrial and distribution property.

 

Of the 4,378 properties in the portfolio, 4,359, or 99.6%, are single-tenant properties, and the remaining are multi-tenant properties. At March 31, 2015, of the 4,359 single-tenant properties, 4,273 were leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 10.1 years.

 

Investment Philosophy

We believe that owning an actively managed, diversified portfolio of commercial properties under long-term, net leases produces consistent and predictable income. A net lease typically requires the tenant to be responsible for minimum monthly rent and certain property operating expenses including property taxes, insurance, and maintenance. In addition, tenants of our properties typically pay rent increases based on: (1) increases in the consumer price index (typically subject to ceilings), (2) fixed increases, or (3) additional rent calculated as a percentage of the tenants’ gross sales above a specified level. We believe that a portfolio of properties under long-term, net leases generally produces a more predictable income stream than many other types of real estate portfolios, while continuing to offer the potential for growth in rental income.

 

Diversification is also a key component of our investment philosophy.  We believe that diversification of the portfolio by tenant, industry, geography, and, to a certain extent, property type leads to more predictable investment results for our shareholders by reducing vulnerability that can come with any single concentration.  Our investment efforts have led to a diversified property portfolio that, as of March 31, 2015, consisted of 4,378 properties located in 49 states and Puerto Rico, leased to 236 different commercial tenants doing business in 47 industry segments. Each of the 47 industry segments, represented in our property portfolio, individually accounted for no more than 10% of our rental revenue for the quarter ended March 31, 2015.  Since 1970, our occupancy rate at the end of each year has never been below 96%.  However, we cannot assure you that our future occupancy levels will continue to equal or exceed 96%.

 

Investment Strategy

Our investment strategy is to act as a source of capital to regional and national tenants by acquiring and leasing back their real estate locations. When identifying new properties for investment, we generally focus on acquiring the real estate tenants consider important to the successful operation of their business. We generally seek to acquire real estate that has the following characteristics:

 

-21-



Table of Contents

 

·                  Properties that are freestanding, commercially-zoned with a single tenant;

·                  Properties that are in significant markets or strategic locations critical to generating revenue for regional and national tenants (i.e. they need the property in which they operate in order to conduct their business);

·                  Properties that we deem to be profitable for the tenants and/or can generally be characterized as important to the successful operations of the company’s business;

·                  Properties that are located within attractive demographic areas relative to the business of our tenants, and have good visibility and easy access to major thoroughfares;

·                  Properties with real estate valuations that approximate replacement costs;

·                  Properties with rental or lease payments that approximate market rents; and

·                  Properties that can be purchased with the simultaneous execution or assumption of long-term, net lease agreements, offering both current income and the potential for future rent increases.

 

We seek to invest in industries in which several, well-organized, regional and national tenants are capturing market share through service, quality control, economies of scale, strong consumer brands, advertising, and the selection of prime locations. In addition, we frequently acquire large portfolios of single-tenant properties net leased to different tenants in a variety of industries.  We have an internal team dedicated to sourcing such opportunities, often using our relationships with various tenants, owners/developers, and advisers to uncover and secure transactions.  We also undertake thorough research and analysis to identify what we consider to be appropriate industries, tenants, and property locations for investment. This research expertise is instrumental to uncovering net lease opportunities in markets where we believe we can add value.

 

In selecting potential investments, we look for tenants with the following attributes:

 

·                  Tenants with reliable and sustainable cash flow;

·                  Tenants with revenue and cash flow from multiple sources;

·                  Tenants that are willing to sign a long-term lease (10 or more years); and

·                  Tenants that are large owners and users of real estate.

 

From a retail perspective, our investment strategy is to target tenants that have a service, non-discretionary, and/or low-price-point component to their business.  We believe these characteristics better position tenants to operate in a variety of economic conditions and to compete more effectively with internet retailers.  As a result of the execution of this strategy, over 90% of our retail rental revenue for the first three months of 2015 is derived from tenants with a service, non-discretionary, and/or low price point component to their business.  From a non-retail perspective, we target industrial and distribution properties leased to Fortune 1000, primarily investment grade rated companies.  We believe rental revenue generated from businesses with these characteristics is generally more durable and stable.

 

After applying this investment strategy, we pursue those transactions where we can achieve an attractive investment spread over our cost of capital and favorable risk-adjusted return.

 

Underwriting Strategy

We believe the principal financial obligations for most of our tenants typically include their bank and other debt, payment obligations to suppliers, and real estate lease obligations. Because we typically own the land and building in which a tenant conducts its business or which are critical to the tenant’s ability to generate revenue, we believe the risk of default on a tenant’s lease obligation is less than the tenant’s unsecured general obligations. It has been our experience that tenants must retain their profitable and critical locations in order to survive.  Therefore, in the event of reorganization, they are less likely to reject a lease of a profitable or critical location because this would terminate their right to use the property. Thus, as the property owner, we believe that we will fare better than unsecured creditors of the same tenant in the event of reorganization. If a property is rejected by the tenant during reorganization, we own the property and can either lease it to a new tenant or sell the property. In addition, we believe that the risk of default on real estate leases can be further mitigated by monitoring the performance of the tenants’ individual locations and considering whether to sell locations that are weaker performers.

 

In order to be considered for acquisition, properties must meet stringent investment and credit requirements. The properties must generate attractive current yields and the tenant must meet our credit criteria. We have established a four-part analysis that examines each potential investment based on:

 

-22-



Table of Contents

 

·                  Industry, company, market conditions, and credit profile;

·                  Store profitability for retail locations, if profitability data is available;

·                  Overall real estate characteristics, including property value and comparative rental rates; and

·                  The importance of the real estate location to the operations of the tenants’ business.

 

Prior to entering into any transaction, our research department conducts a review of a tenant’s credit quality.  The information reviewed may include reports and filings, including any public credit ratings, financial statements, debt and equity analyst reports, and reviews of corporate credit spreads, stock prices, market capitalization, and other financial metrics.  We conduct additional due diligence, including additional financial reviews of the tenant and a more comprehensive review of the business segment and industry in which the tenant operates.  We continue to monitor our tenants’ credit quality on an ongoing basis by reviewing the available information previously discussed, and providing summaries of these findings to management.  We estimate that approximately 48% of our annualized rental revenue comes from properties leased to investment grade rated companies or their subsidiaries.  At March 31, 2015, our top 20 tenants represent approximately 54% of our annualized revenue and ten of these tenants have investment grade credit ratings.

 

Asset Management Strategy

The active management of the property portfolio is an essential component of our long-term strategy. We continually monitor our portfolio for any changes that could affect the performance of the industries, tenants and locations in which we have invested. We also regularly analyze our portfolio with a view toward optimizing its returns and enhancing the credit quality of our portfolio.

 

We regularly review and analyze:

 

·                  The performance of the various industries of our tenants;

·                  The operation, management, business planning, and financial condition of our tenants; and

·                  The quality of the underlying real estate locations.

 

We have an active asset management program that incorporates the sale of assets when we believe the reinvestment of the sale proceeds will:

 

·                 Generate higher returns;

·                  Enhance the credit quality of our real estate portfolio;

·                  Extend our average remaining lease term; or

·                  Decrease tenant or industry concentration.

 

At March 31, 2015, we classified real estate with a carrying amount of $9.4 million as held for sale on our balance sheet. For the remainder of 2015, we intend to continue our active disposition efforts to further enhance our real estate portfolio and anticipate approximately $50 million in property sales for all of 2015.  We intend to invest these proceeds into new property acquisitions, if there are attractive opportunities available. However, we cannot guarantee that we will sell properties during the next 12 months at our estimated values or be able to invest the property sale proceeds in new properties.

 

Impact of Real Estate and Credit Markets

In the commercial real estate market, property prices generally continue to fluctuate. Likewise, during certain periods, the U.S. credit markets have experienced significant price volatility, dislocations, and liquidity disruptions, which may impact our access to and cost of capital. We continually monitor the commercial real estate and U.S. credit markets carefully and, if required, will make decisions to adjust our business strategy accordingly.

 

RECENT DEVELOPMENTS

 

Increases in Monthly Dividends to Common Stockholders

We have continued our 46-year policy of paying monthly dividends.  In addition, we increased the dividend three times during 2015.  As of April 2015, we have paid 70 consecutive quarterly dividend increases and increased the dividend 80 times since our listing on the NYSE in 1994.

 

 

 

Month

 

Month

 

Dividend

 

Increase

2015 Dividend increases

 

Declared

 

Paid

 

per share

 

per share

1st increase

 

Dec 2014

 

Jan 2015

 

$ 0.1834167

 

$ 0.0003125

2nd increase

 

Jan 2015

 

Feb 2015

 

0.1890000

 

0.0055833

3rd increase

 

Mar 2015

 

Apr 2015

 

0.1895000

 

0.0005000

 

-23-



Table of Contents

 

The dividends paid per share during the first three months of 2015 as compared to the first three months of 2014 increased 2.6%.  The dividends paid per share during the first three months of 2015 totaled approximately $0.561, as compared to approximately $0.547 during the first three months of 2014, an increase of $0.014.

 

The monthly dividend of $0.1895 per share represents a current annualized dividend of $2.274 per share, and an annualized dividend yield of approximately 4.4% based on the last reported sale price of our common stock on the NYSE of $51.60 on March 31, 2015. Although we expect to continue our policy of paying monthly dividends, we cannot guarantee that we will maintain our current level of dividends, that we will continue our pattern of increasing dividends per share, or what our actual dividend yield will be in any future period.

 

Acquisitions during the First Three Months of 2015

During the first three months of 2015, we invested $209.9 million in 83 new properties and properties under development or expansion, with an initial weighted average contractual lease rate of 6.9%. The 83 new properties and properties under development or expansion are located in 24 states, will contain approximately 1.6 million leasable square feet, and are 100% leased with a weighted average lease term of 15.5 years. The tenants occupying the new properties operate in 12 industries and the property types consist of 74.2% retail and 25.8% industrial and distribution, based on rental revenue.  During the first three months of 2015, none of our real estate investments caused any one tenant to be 10% or more of our total assets at March 31, 2015.

 

The estimated initial weighted average contractual lease rate for a property is generally computed as estimated contractual net operating income, which, in the case of a net leased property, is equal to the aggregate base rent for the first full year of each lease, divided by the total cost of the property.  Since it is possible that a tenant could default on the payment of contractual rent, we cannot provide assurance that the actual return on the funds invested will remain at the percentage listed above.

 

In the case of a property under development or expansion, the contractual lease rate is generally fixed such that rent varies based on the actual total investment in order to provide a fixed rate of return.  When the lease does not provide for a fixed rate of return on a property under development or expansion, the estimated initial weighted average contractual lease rate is computed as follows: estimated net operating income (determined by the lease) for the first full year of each lease, divided by our projected total investment in the property, including land, construction and capitalized interest costs. Of the $209.9 million we invested during the first three months of 2015, $15.3 million was invested in 25 properties under development or expansion with an estimated initial weighted average contractual lease rate of 9.0%.  We may continue to pursue development or expansion opportunities under similar arrangements in the future.

 

Portfolio Discussion

 

Leasing Results

At March 31, 2015, we had 86 properties available for lease out of 4,378 properties in our portfolio, which represents a 98.0% occupancy rate.  Since December 31, 2014, when we reported 70 properties available for lease out of 4,327 and a 98.4% occupancy rate, we:

 

·                  Had 64 lease expirations;

·                  Re-leased 43 properties; and

·                  Sold five vacant properties.

 

Of the 43 properties re-leased during the first three months of 2015, 30 properties were re-leased to existing tenants, two were re-leased to new tenants without vacancy, and 11 were re-leased to new tenants after a period of vacancy.  The annual rent on these 43 leases was $11.7 million, as compared to the previous rent on these same properties of $11.8 million, which represents a rent recapture rate of 99.2%.

 

At March 31, 2015, our average annualized rental revenue was approximately $13.20 per square foot on the 4,292 leased properties in our portfolio.  At March 31, 2015, we classified seven properties with a carrying amount of $9.4 million as held for sale on our balance sheet.  The disposal of these properties does not represent a strategic shift that will have a major effect on our operations and financial results.

 

Investments in Existing Properties

In the first three months of 2015, we capitalized costs of $1.3 million on existing properties in our portfolio, consisting of $313,000 for re-leasing costs and $1.0 million for building and tenant improvements.  In the first three months of 2014, we capitalized costs of $1.4 million on existing properties in our portfolio, consisting of $192,000 for re-leasing costs and $1.2 million for building and tenant improvements.

 

-24-



Table of Contents

 

As part of our re-leasing costs, we typically pay leasing commissions and sometimes provide tenant rent concessions.  Leasing commissions are paid based on the commercial real estate industry standard and any rent concessions provided are minimal.  We do not consider the collective impact of the leasing commissions or tenant rent concessions to be material to our financial position or results of operations.

 

The majority of our building and tenant improvements relate to roof repairs, HVAC improvements, and parking lot resurfacing and replacements.  It is not customary for us to offer significant tenant improvements on our properties as tenant incentives.  The amounts of our capital expenditures can vary significantly, depending on the rental market, tenant credit worthiness, the lease term and the willingness of tenants to pay higher rents over the terms of the leases.

 

Inclusion in S&P Indices

In January 2015, we were added to the S&P High Yield Dividend Aristocrats® index. In April 2015, we were added to the S&P 500 index and are one of 24 REITs, and the only net lease REIT included in this index.

 

Issuance of Common Stock

In April 2015, we issued 5,500,000 shares of common stock.  After underwriting discounts and other offering costs of $1.5 million, the net proceeds of $276.3 million were used to repay borrowings under our acquisition credit facility.

 

Dividend Reinvestment and Stock Purchase Plan

We have established a Dividend Reinvestment and Stock Purchase Plan, or the DRSPP, to provide our common stockholders, as well as new investors, with a convenient and economical method of purchasing our common stock and reinvesting their distributions.  The DRSPP also allows our current stockholders to buy additional shares of common stock by reinvesting all or a portion of their distributions.  The DRSPP authorizes up to 11,000,000 common shares to be issued.  During the first three months of 2015, we issued 2,023,276 shares and raised approximately $102.2 million under the DRSPP.

 

Net Income Available to Common Stockholders

Net income available to common stockholders was $60.5 million in the first three months of 2015, compared to $47.2 million in the first three months of 2014, an increase of $13.3 million. On a diluted per common share basis, net income was $0.27 in the first three months of 2015, as compared to $0.23 in the first three months of 2014, an increase of $0.04, or 17.4%.

 

The calculation to determine net income available to common stockholders includes impairments and/or gains from the sale of properties. The amount of impairments and/or gains varies from period to period based on the timing of property sales and can significantly impact net income available to common stockholders.

 

Gains from the sale of properties during the first three months of 2015 were $7.2 million, as compared to gains from the sale of properties of $3.9 million during the first three months of 2014.

 

Funds from Operations Available to Common Stockholders (FFO)

In the first three months of 2015, our FFO increased by $18.4 million, or 13.7%, to $152.9 million versus $134.5 million in the first three months of 2014.  On a diluted per common share basis, FFO was $0.68 in the first three months of 2015, compared to $0.65 in the first three months of 2014, an increase of $0.03, or 4.6%.

 

Adjusted Funds from Operations Available to Common Stockholders (AFFO)

 

In the first three months of 2015, our AFFO increased by $19.4 million, or 14.6%, to $152.1 million versus $132.7 million in the first three months of 2014. On a diluted per common share basis, AFFO was $0.67 in the first three months of 2015, compared to $0.64 in the first three months of 2014, an increase of $0.03, or 4.7%.

 

See our discussion of FFO and AFFO (which are not financial measures under GAAP), later in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which includes a reconciliation of net income available to common stockholders to FFO and AFFO.

 

-25-



Table of Contents

 

LIQUIDITY AND CAPITAL RESOURCES

 

Capital Philosophy

Historically, we have met our long-term capital needs by issuing common stock, preferred stock and long-term unsecured notes and bonds. Over the long term, we believe that common stock should be the majority of our capital structure. However, we may issue additional preferred stock or debt securities. We may issue common stock when we believe that our share price is at a level that allows for the proceeds of any offering to be accretively invested into additional properties. In addition, we may issue common stock to permanently finance properties that were financed by our credit facility or debt securities. However, we cannot assure you that we will have access to the capital markets at times and at terms that are acceptable to us.

 

Our primary cash obligations, for the current year and subsequent years, are included in the “Table of Obligations,” which is presented later in this section. We expect to fund our operating expenses and other short-term liquidity requirements, including property acquisitions and development costs, payment of principal and interest on our outstanding indebtedness, property improvements, re-leasing costs and cash distributions to common and preferred stockholders, primarily through cash provided by operating activities, borrowing on our $1.5 billion credit facility and periodically through public securities offerings.

 

Conservative Capital Structure

We believe that our stockholders are best served by a conservative capital structure. Therefore, we seek to maintain a conservative debt level on our balance sheet and solid interest and fixed charge coverage ratios. At March 31, 2015, our total outstanding borrowings of senior unsecured notes and bonds, term loan, mortgages payable and credit facility borrowings were $5.02 billion, or approximately 29.2% of our total market capitalization of $17.19 billion.

 

We define our total market capitalization at March 31, 2015 as the sum of:

 

·                  Shares of our common stock outstanding of 227,031,104, plus total common units outstanding of 736,568, multiplied by the last reported sales price of our common stock on the NYSE of $51.60 per share on March 31, 2015, or $11.75 billion;

·                  Aggregate liquidation value (par value of $25.00 per share) of the Class F preferred stock of $408.8 million;

·                  Outstanding borrowings of $370.0 million on our credit facility;

·                  Outstanding mortgages payable of $784.7 million, excluding net mortgage premiums of $14.6 million;

·                  Outstanding borrowings of $70.0 million on our term loan; and

·                  Outstanding senior unsecured notes and bonds of $3.8 billion, excluding unamortized original issuance discounts of $14.3 million.

 

Universal Shelf Registration

In February 2013, we filed a shelf registration statement with the SEC, which is effective for a term of three years and will expire in February 2016. This replaced our prior shelf registration statement.  In accordance with SEC rules, the amount of securities to be issued pursuant to this shelf registration statement was not specified when it was filed and there is no specific dollar limit. The securities covered by this registration statement include (1) common stock, (2) preferred stock, (3) debt securities, (4) depositary shares representing fractional interests in shares of preferred stock, (5) warrants to purchase debt securities, common stock, preferred stock, or depositary shares, and (6) any combination of these securities. We may periodically offer one or more of these securities in amounts, prices and on terms to be announced when and if these securities are offered. The specifics of any future offerings, along with the use of proceeds of any securities offered, will be described in detail in a prospectus supplement, or other offering materials, at the time of any offering.

 

Mortgage Debt

As of March 31, 2015, we had $784.7 million of mortgages payable, all of which were assumed in connection with our property acquisitions.  Additionally, at March 31, 2015, we had net premiums totaling $14.6 million on these mortgages.  We expect to pay off the mortgages payable as soon as prepayment penalties have declined to a level that will make it economically feasible to do so.  During the first three months of 2015, we made $51.3 million of principal payments, including the repayment of three mortgages in full for $49.4 million.

 

-26-



Table of Contents

 

Term Loan

In January 2013, in conjunction with our acquisition of ARCT, we entered into a $70 million senior unsecured term loan maturing in January 2018.  Borrowing under the term loan bears interest at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 1.20%.  In conjunction with this term loan, we also acquired an interest rate swap which essentially fixes our per annum interest rate on the term loan at 2.15%.

 

$1.5 Billion Acquisition Credit Facility

We have a $1.5 billion unsecured acquisition credit facility with an initial term that expires in May 2016 and includes, at our election, a one-year extension option. Under this credit facility, our current investment grade credit ratings provide for financing at LIBOR, plus 1.075% with a facility commitment fee of 0.175%, for all-in drawn pricing of 1.25% over LIBOR. The borrowing rate is not subject to an interest rate floor or ceiling. We also have other interest rate options available to us under this credit facility. Our credit facility is unsecured and, accordingly, we have not pledged any assets as collateral for this obligation.

 

At March 31, 2015, we had a borrowing capacity of $1.13 billion available on our credit facility (subject to customary conditions to borrowing) and an outstanding balance of $370.0 million.  As of April 10, 2015, we had a borrowing capacity of approximately $1.4 billion available on our credit facility after using proceeds from our April common stock offering to repay borrowings on our credit facility. The interest rate on borrowings outstanding under our credit facility, at March 31, 2015, was 1.2% per annum.  We must comply with various financial and other covenants in our credit facility.  At March 31, 2015, we remain in compliance with these covenants. We expect to use our credit facility to acquire additional properties and for other corporate purposes. Any additional borrowings will increase our exposure to interest rate risk. We regularly review our credit facility and may seek to extend or replace our credit facility, to the extent we deem appropriate.

 

We generally use our credit facility for the short-term financing of new property acquisitions. Thereafter, when capital is available on acceptable terms, we generally seek to refinance those borrowings with the net proceeds of long-term or permanent financing, which may include the issuance of common stock, preferred stock or debt securities. We cannot assure you, however, that we will be able to obtain any such refinancing, or that market conditions prevailing at the time of the refinancing will enable us to issue equity or debt securities at acceptable terms.

 

Notes Outstanding

Our senior unsecured note and bond obligations consist of the following as of March 31, 2015, sorted by maturity date (dollars in millions):

 

5.5% notes, issued in November 2003 and due in November 2015

 

$

150

 

5.95% notes, issued in September 2006 and due in September 2016

 

275

 

5.375% notes, issued in September 2005 and due in September 2017

 

175

 

2.0% notes, issued in October 2012 and due in January 2018

 

350

 

6.75% notes, issued in September 2007 and due in August 2019

 

550

 

5.75% notes, issued in June 2010 and due in January 2021

 

250

 

3.25% notes, issued in October 2012 and due in October 2022

 

450

 

4.65% notes, issued in July 2013 and due in August 2023

 

750

 

3.875% notes, issued in June 2014 and due in July 2024

 

350

 

4.125% notes, issued in September 2014 and due in October 2026

 

250

 

5.875% bonds, $100 issued in March 2005 and $150 issued in

 

 

 

June 2011, both due in March 2035

 

250

 

Total principal amount

 

$

3,800

 

Unamortized original issuance discounts

 

(14

)

 

 

$

3,786

 

 

All of our outstanding notes and bonds have fixed interest rates and contain various covenants, which we remain in compliance with at March 31, 2015. Additionally, interest on all of our senior note and bond obligations is paid semiannually.

 

-27-



Table of Contents

 

The following is a summary of the key financial covenants for our senior unsecured notes, as defined and calculated per the terms of our senior notes and bonds. These calculations, which are not based on U.S. generally accepted accounting principles, or GAAP, measurements, are presented to investors to show our ability to incur additional debt under the terms of our senior notes and bonds as well as to disclose our current compliance with such covenants, and are not measures of our liquidity or performance.  The actual amounts as of March 31, 2015 are:

 

Note Covenants

 

Required

 

Actual

 

 

 

 

 

 

 

Limitation on incurrence of total debt

 

< 60% of adjusted assets

 

43.6%

 

Limitation on incurrence of secured debt

 

< 40% of adjusted assets

 

6.9%

 

Debt service coverage (trailing 12 months)(1)

 

> 1.5 x

 

3.9x

 

Maintenance of total unencumbered assets

 

> 150% of unsecured debt

 

237.2%

 

 

(1) This covenant is calculated on a pro forma basis for the preceding four-quarter period on the assumption that: (i) the incurrence of any Debt (as defined in the covenants) incurred by us since the first day of such four-quarter period and the application of the proceeds therefrom (including to refinance other Debt since the first day of such four-quarter period), (ii) the repayment or retirement of any of our Debt since the first day of such four-quarter period, and (iii) any acquisition or disposition by us of any asset or group since the first day of such four-quarters had in each case occurred on April 1, 2014, and subject to certain additional adjustments.  Such pro forma ratio has been prepared on the basis required by that debt service covenant, reflects various estimates and assumptions and is subject to other uncertainties, and therefore does not purport to reflect what our actual debt service coverage ratio would have been had transactions referred to in clauses (i), (ii) and (iii) of the preceding sentence occurred as of April 1, 2014, nor does it purport to reflect our debt service coverage ratio for any future period.  The following is our calculation of debt service coverage at March 31, 2015 (in thousands, for trailing twelve months):

 

Net income attributable to the Company

 

     $

280,237

 

Plus: interest expense

 

214,673

 

Plus: provision for taxes

 

3,445

 

Plus: depreciation and amortization

 

382,729

 

Plus: provisions for impairment

 

5,041

 

Plus: pro forma adjustments

 

27,334

 

Less: gain on sales of real estate

 

(45,427

)

Income available for debt service, as defined

 

     $

868,032

 

Total pro forma debt service charge

 

     $

225,022

 

Debt service coverage ratio

 

3.9

 

 

Fixed Charge Coverage Ratio

Fixed charge coverage ratio is calculated in exactly the same manner as the debt service coverage ratio, except that preferred stock dividends are also added to the denominator.  Similar to debt service coverage ratio, we consider fixed charge coverage ratio to be an appropriate supplemental measure of a company’s ability to make its interest and preferred stock dividend payments.  Our calculations of both debt service and fixed charge coverage ratios may be different from the calculations used by other companies and, therefore, comparability may be limited.  The presentation of debt service and fixed charge coverage ratios should not be considered as alternatives to any U.S. GAAP operating performance measures.  Below is our calculation of fixed charges at March 31, 2015 (in thousands, for the trailing twelve months):

 

Income available for debt service, as defined

 

$

868,032

 

Pro forma debt service charge plus preferred stock dividends

 

$

252,102

 

Fixed charge coverage ratio

 

3.4

 

 

Cash Reserves

We are organized to operate as an equity REIT that acquires and leases properties and distributes to stockholders, in the form of monthly cash distributions, a substantial portion of our net cash flow generated from leases on our properties.  We intend to retain an appropriate amount of cash as working capital.  At March 31, 2015, we had cash and cash equivalents totaling $12.2 million.

 

We believe that our cash and cash equivalents on hand, cash provided from operating activities, and borrowing capacity is sufficient to meet our liquidity needs for the next twelve months.  We intend, however, to use permanent or long-term capital to fund property acquisitions and to repay future borrowings under our credit facility.

 

-28-



Table of Contents

 

Credit Agency Ratings

The borrowing interest rates under our credit facility are based upon our ratings assigned by credit rating agencies. We are currently assigned the following investment grade corporate credit ratings on our senior unsecured notes and bonds:  Moody’s Investors Service has assigned a rating of Baa1 with a “stable” outlook, Standard & Poor’s Ratings Group has assigned a rating of BBB+ with a “stable” outlook to our senior notes, and Fitch Ratings has assigned a rating of BBB+ with a “stable” outlook.

 

Based on our current ratings, the current facility interest rate is LIBOR plus 1.075% with a facility commitment fee of 0.175%, for all-in drawn pricing of 1.25% over LIBOR.  The credit facility provides that the interest rate can range between: (i) LIBOR plus 1.85% if our credit rating is lower than BBB-/Baa3 and (ii) LIBOR plus 1.00% if our credit rating is A-/A3 or higher.  In addition, our credit facility provides for a facility commitment fee based on our credit ratings, which range from: (i) 0.45% for a rating lower than BBB-/Baa3, and (ii) 0.15% for a credit rating of A-/A3 or higher.

 

We also issue senior debt securities from time to time and our credit ratings can impact the interest rates charged in those transactions.  If our credit ratings or ratings outlook change, our cost to obtain debt financing could increase or decrease.

 

The credit ratings assigned to us could change based upon, among other things, our results of operations and financial condition. These ratings are subject to ongoing evaluation by credit rating agencies and we cannot assure you that our ratings will not be changed or withdrawn by a rating agency in the future if, in its judgment, circumstances warrant. Moreover, a rating is not a recommendation to buy, sell or hold our debt securities, preferred stock or common stock.

 

Table of Obligations

The following table summarizes the maturity of each of our obligations as of March 31, 2015 (dollars in millions):

 

 

 

 

 

 

 

 

 

 

 

 

 

Ground

 

 

Ground

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Leases

 

 

Leases

 

 

 

 

 

 

 

 

 

Notes

 

 

 

 

 

 

 

Paid by

 

 

Paid by

 

 

 

 

 

Year of

 

Credit

 

and

 

Term

 

Mortgages

 

 

 

Realty

 

Our

 

 

 

 

Maturity

 

Facility

(1)

Bonds

(2)

Loan

 

Payable

(3)

Interest

(4)

Income

(5)

Tenants

(6)

Other

(7)

Totals

2015

 

$

-

 

$

150.0

 

$

-

 

$

68.4

 

$

168.7

 

$

0.7

 

$

9.5

 

$

56.5

 

$

453.8

2016

 

 

-

 

 

275.0

 

 

-

 

 

248.4

 

 

200.4

 

 

1.0

 

 

12.8

 

 

-

 

 

737.6

2017

 

 

370.0

 

 

175.0

 

 

-

 

 

142.5

 

 

175.3

 

 

1.1

 

 

12.9

 

 

-

 

 

876.8

2018

 

 

-

 

 

350.0

 

 

70.0

 

 

15.1

 

 

155.4

 

 

1.0

 

 

12.9

 

 

-

 

 

604.4

2019

 

 

-

 

 

550.0

 

 

-

 

 

26.0

 

 

140.2

 

 

0.9

 

 

12.8

 

 

-

 

 

729.9

Thereafter

 

 

-

 

 

2,300.0

 

 

-

 

 

284.3

 

 

567.9

 

 

8.5

 

 

131.9

 

 

-

 

 

3,292.6

Totals

 

$

370.0

 

$

3,800.0

 

$

70.0

 

$

784.7

 

$

1,407.9

 

$

13.2

 

$

192.8

 

$

56.5

 

$

6,695.1

 

(1) The initial term of the credit facility expires in May 2016 and includes, at our option, a one-year extension, which has been assumed to occur in the table above.

(2) Excludes non-cash original issuance discounts recorded on the notes payable.  The unamortized balance of the original issuance discounts at March 31, 2015, is $14.3 million.

(3) Excludes non-cash net premiums recorded on the mortgages payable.  The unamortized balance of these net premiums at March 31, 2015, is $14.6 million.

(4) Interest on the term loan, notes, bonds, mortgages payable, and credit facility has been calculated based on outstanding balances as of March 31, 2015 through their respective maturity dates.

(5) Realty Income currently pays the ground lessors directly for the rent under the ground leases.

(6) Our tenants, who are generally sub-tenants under ground leases, are responsible for paying the rent under these ground leases. In the event a tenant fails to pay the ground lease rent, we are primarily responsible.

(7) “Other” consists of $54.5 million of commitments under construction contracts and $2.0 million of commitments for tenant improvements and leasing costs.

 

Our credit facility and notes payable obligations are unsecured. Accordingly, we have not pledged any assets as collateral for these obligations.

 

Preferred Stock and Preferred Units Outstanding

In 2006, we issued 8,800,000 shares of Class E preferred stock at a price of $25.00 per share. In October 2014, we redeemed all of the 8,800,000 shares of our Class E preferred stock for $25.00 per share, plus accrued dividends. In the third quarter of 2014, we incurred a charge of $6.0 million, representing the Class E preferred stock original issuance costs that we paid in 2006.

 

-29-



Table of Contents

 

In February 2012, we issued 14,950,000 shares of our Class F preferred stock at $25.00 per share. In April 2012, we issued an additional 1,400,000 shares of Class F preferred stock at $25.2863 per share. Beginning February 15, 2017, shares of our Class F preferred stock are redeemable at our option for $25.00 per share, plus any accrued and unpaid dividends. Dividends on the shares of our Class F preferred stock are paid monthly in arrears. We are current on our obligations to pay dividends on our Class F preferred stock.

 

As part of our acquisition of ARCT in January 2013, we issued 6,750 partnership units, with a carrying value of $6.75 million. Payments on these preferred units were made monthly in arrears at rate of 2% per annum, or $135,000, and are included in interest expense. In January 2015, we redeemed all 6,750 Tau Operating Partnership preferred units for $1,000 per unit, plus accrued and unpaid distributions.

 

No Unconsolidated Investments

We have no unconsolidated investments, nor do we engage in trading activities involving energy or commodity contracts.

 

Dividend Policy

Distributions are paid monthly to holders of shares of our common stock and Class F preferred stock if, and when, declared by our Board of Directors.

 

Distributions are paid monthly to the limited partners holding common units of Tau Operating Partnership, L.P. and Realty Income, L.P., each on a per unit basis that is generally equal to the amount paid per share to our common stockholders.

In order to maintain our status as a REIT for federal income tax purposes, we generally are required to distribute dividends to our stockholders aggregating annually at least 90% of our taxable income (excluding net capital gains), and we are subject to income tax to the extent we distribute less than 100% of our taxable income (including net capital gains). In 2014, our cash distributions to preferred and common stockholders totaled $519.1 million, or approximately 154.6% of our estimated taxable income of $335.7 million. Our estimated taxable income reflects non-cash deductions for depreciation and amortization. Our estimated taxable income is presented to show our compliance with REIT dividend requirements and is not a measure of our liquidity or operating performance.  We intend to continue to make distributions to our stockholders that are sufficient to meet this dividend requirement and that will reduce or eliminate our exposure to income taxes. Furthermore, we believe our funds from operations are more than sufficient to support our current level of cash distributions to our stockholders. Our cash distributions to common stockholders, for the first three months of 2015, totaled $126.7 million, representing 83.3% of our adjusted funds from operations available to common stockholders of $152.1 million. In comparison, our 2014 cash distributions to common stockholders totaled $479.3 million, representing 85.3% of our adjusted funds from operations available to common stockholders of $561.7 million.

 

The Class F preferred stockholders receive cumulative distributions at a rate of 6.625% per annum on the $25.00 per share liquidation preference (equivalent to $1.65625 per annum per share). Dividends on our Class F preferred stock are current.

 

Future distributions will be at the discretion of our Board of Directors and will depend on, among other things, our results of operations, FFO, AFFO, cash flow from operations, financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code of 1986, as amended, our debt service requirements, and any other factors the Board of Directors may deem relevant. In addition, our credit facility contains financial covenants that could limit the amount of distributions payable by us in the event of a default, and which prohibit the payment of distributions on the common or preferred stock in the event that we fail to pay when due (subject to any applicable grace period) any principal or interest on borrowings under our credit facility.

 

Distributions of our current and accumulated earnings and profits for federal income tax purposes generally will be taxable to stockholders as ordinary income, except to the extent that we recognize capital gains and declare a capital gains dividend, or that such amounts constitute “qualified dividend income” subject to a reduced rate of tax. The maximum tax rate of non-corporate taxpayers for “qualified dividend income” is generally 20%. In general, dividends payable by REITs are not eligible for the reduced tax rate on qualified dividend income, except to the extent that certain holding requirements have been met with respect to the REIT’s stock and the REIT’s dividends are attributable to dividends received from certain taxable corporations (such as our taxable REIT subsidiaries) or to income that was subject to tax at the corporate or REIT level (for example, if we distribute taxable income that we retained and paid tax on in the prior taxable year).

 

-30-



Table of Contents

 

Distributions in excess of earnings and profits generally will first be treated as a non-taxable reduction in the stockholders’ basis in their stock, but not below zero. Distributions in excess of that basis generally will be taxable as a capital gain to stockholders who hold their shares as a capital asset. Approximately 24.8% of the distributions to our common stockholders, made or deemed to have been made in 2014, were classified as a return of capital for federal income tax purposes. We estimate that in 2015, between 20% and 35% of the distributions may be classified as a return of capital.

 

RESULTS OF OPERATIONS

 

Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with GAAP, and are the basis for our discussion and analysis of financial condition and results of operations. Preparing our consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. We believe that we have made these estimates and assumptions in an appropriate manner and in a way that accurately reflects our financial condition. We continually test and evaluate these estimates and assumptions using our historical knowledge of the business, as well as other factors, to ensure that they are reasonable for reporting purposes. However, actual results may differ from these estimates and assumptions. This summary should be read in conjunction with the more complete discussion of our accounting policies and procedures included in note 2 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2014.

 

In order to prepare our consolidated financial statements according to the rules and guidelines set forth by GAAP, many subjective judgments must be made with regard to critical accounting policies. One of these judgments is our estimate for useful lives in determining depreciation expense for our properties. Depreciation on a majority of our buildings and improvements is computed using the straight-line method over an estimated useful life of 25 to 35 years for buildings and 4 to 20 years for improvements, which we believe are appropriate estimates of useful life. If we use a shorter or longer estimated useful life, it could have a material impact on our results of operations.

 

Management must make significant assumptions in determining the fair value of assets acquired and liabilities assumed.  When acquiring a property for investment purposes, we typically allocate the fair value of real estate acquired to: (1) land, (2) building and improvements, and (3) identified intangible assets and liabilities, based in each case on their estimated fair values. Intangible assets and liabilities consist of above-market or below-market lease value of in-place leases, the value of in-place leases, and tenant relationships, as applicable.  In an acquisition of multiple properties, we must also allocate the purchase price among the properties.  The allocation of the purchase price is based on our assessment of estimated fair value and is often based upon the expected future cash flows of the property and various characteristics of the market where the property is located.  In addition, any assumed mortgages receivable or payable and any assumed or issued noncontrolling interests are recorded at their estimated fair values. The estimated fair values of our mortgages payable have been calculated by discounting the future cash flows using applicable interest rates that have been adjusted for factors, such as industry type, tenant investment grade, maturity date, and comparable borrowings for similar assets.  The initial allocation of the purchase price is based on management’s preliminary assessment, which may differ when final information becomes available.  Subsequent adjustments made to the initial purchase price allocation are made within the allocation period, which does not exceed one year.  The use of different assumptions in the allocation of the purchase price of the acquired properties and liabilities assumed could affect the timing of recognition of the related revenue and expenses.

 

Another significant judgment must be made as to if, and when, impairment losses should be taken on our properties when events or a change in circumstances indicate that the carrying amount of the asset may not be recoverable. A provision is made for impairment if estimated future operating cash flows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value of the property. Key inputs that we estimate in this analysis include projected rental rates, estimated holding periods, capital expenditures, and property sales capitalization rates. If a property is held for sale, it is carried at the lower of carrying cost or estimated fair value, less estimated cost to sell. The carrying value of our real estate is the largest component of our consolidated balance sheets. Our strategy of primarily holding

 

-31-



Table of Contents

 

properties, long-term, directly decreases the likelihood of their carrying values not being recoverable, thus requiring the recognition of an impairment. However, if our strategy, or one or more of the above assumptions were to change in the future, an impairment may need to be recognized. If events should occur that require us to reduce the carrying value of our real estate by recording provisions for impairment, they could have a material impact on our results of operations.

 

The following is a comparison of our results of operations for the three months ended March 31, 2015, to the three months ended March 31, 2014.

 

Rental Revenue

Rental revenue was $235.1 million for the first three months of 2015, as compared to $214.1 million for the first three months of 2014, an increase of $21.0 million, or 9.8%. The increase in rental revenue in the first three months of 2015 compared to the first three months of 2014 is primarily attributable to:

 

·                  The 60 properties (1.0 million square feet) we acquired in the first three months of 2015, which generated $1.5 million of rent in the first three months of 2015;

·                  The 479 properties (9.3 million square feet) we acquired in 2014, which generated $24.0 million of rent in the first three months of 2015 compared to $7.3 million in the first three months of 2014, an increase of $16.7 million;

·                  Same store rents generated on 3,695 properties (59.0 million square feet) during the first three months of 2015 and 2014, increased by $2.7 million, or 1.4%, to $201.1 million from $198.4 million;

·                  A net increase in straight-line rent and other non-cash adjustments to rent of $1.2 million in the first three months of 2015 as compared to the first three months of 2014;

·                  A net decrease of $2.2 million relating to properties sold in the first three months of 2015 and during 2014 that were reported in continuing operations; and

·                  A net increase of $1.1 million relating to the aggregate of (i) rental revenue from properties (117 properties comprising 1.2 million square feet) that were available for lease during part of 2015 or 2014, (ii) rental revenue for twelve properties under development, and (iii) lease termination settlements.  In aggregate, the revenues for these items totaled $5.2 million in the first three months of 2015 compared to $4.1 million in the first three months of 2014.

 

For purposes of determining the same store rent property pool, we include all properties that were owned for the entire year-to-date period, for both the current and prior year, except for properties during the current or prior year that; (i) were vacant at any time, (ii) were under development or redevelopment, and (iii) were involved in eminent domain and rent was reduced. Each of the exclusions from the same store pool are separately addressed within the applicable sentences above, explaining the changes in rental revenue for the period.

 

Of the 4,378 properties in the portfolio at March 31, 2015, 4,359, or 99.6%, are single-tenant properties and the remaining are multi-tenant properties. Of the 4,359 single-tenant properties, 4,273, or 98.0%, were net leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 10.1 years at March 31, 2015. Of our 4,273 leased single-tenant properties, 3,832 or 89.7% were under leases that provide for increases in rents through:

 

·                  Primarily base rent increases tied to a consumer price index (typically subject to ceilings);

·                  Percentage rent based on a percentage of the tenants’ gross sales;

·                  Fixed increases; or

·                  A combination of two or more of the above rent provisions.

 

Percentage rent, which is included in rental revenue, was $1.4 million in the first three months of 2015 and 2014, respectively.  Percentage rent in the first three months of 2015 was less than 1% of rental revenue and we anticipate percentage rent to be less than 1% of rental revenue for the remainder of 2015.

 

Our portfolio of real estate, leased primarily to regional and national tenants under net leases, continues to perform well and provides dependable lease revenue supporting the payment of monthly dividends to our stockholders.  At March 31, 2015, our portfolio of 4,378 properties was 98.0% leased with 86 properties available for lease, as compared to 98.4% occupancy, or 70 properties available for lease at December 31, 2014, and 98.3% occupancy, or 73 properties available for lease at March 31, 2014. It has been our experience that approximately 2% to 4% of our property portfolio will be unleased at any given time; however, it is possible that the number of properties available for lease could exceed these levels in the future.

 

-32-



Table of Contents

 

Tenant Reimbursements

Contractually obligated reimbursements from tenants for recoverable real estate taxes and operating expenses were $10.0 million in the first three months of 2015, compared to $6.4 million in the first three months of 2014.  The increase in tenant reimbursements is primarily due to our acquisitions during 2014 and the first three months of 2015.  Our tenant reimbursements approximate our reimbursable property expenses for any given period.

 

Other Revenue

Other revenue, which comprises property-related revenue not included in rental revenue or tenant reimbursements, was $1.8 million in the first three months of 2015, compared to $1.0 million in the first three months of 2014.

 

Depreciation and Amortization

Depreciation and amortization was $98.0 million for the first three months of 2015, compared to $90.0 million for the first three months of 2014. The increases in depreciation and amortization in the first three months of 2015 was primarily due to the acquisition of properties in 2014 and the first three months of 2015, which was partially offset by property sales in those same periods.  As discussed in the sections entitled “Funds from Operations Available to Common Stockholders (FFO)” and “Adjusted Funds from Operations Available to Common Stockholders (AFFO),” depreciation and amortization is a non-cash item that is added back to net income available to common stockholders for our calculation of FFO and AFFO.

 

Interest Expense

The following is a summary of the components of our interest expense (dollars in thousands):

 

 

 

               Three months ended

 

 

 

                 March 31,

 

 

 

2015

 

2014

 

Interest on our credit facility, term loan, notes, mortgages and interest rate swaps

 

$

56,576

 

$

51,523

 

Credit facility commitment fees

 

656

 

656

 

Amortization of credit facility origination costs and deferred financing costs

 

2,156

 

1,963

 

Loss on interest rate swaps

 

1,058

 

57

 

Amortization of net mortgage premiums

 

(1,961

)

(2,384

)

Capital lease obligation

 

77

 

-

 

Interest capitalized

 

(94

)

(95

)

Interest expense

 

$

58,468

 

$

51,720

 

 

 

 

 

 

 

Credit facility, term loan, mortgages and notes

 

2015

 

2014

 

Average outstanding balances (dollars in thousands)

 

$

4,982,170

 

$

4,539,423

 

Average interest rates

 

4.52

%

4.51

%

 

The increase in interest expense from the first three months of 2014 to the first three months of 2015 was primarily due to the June 2014 issuance of our 3.88% senior unsecured notes due July 2024 and the September 2014 issuance of our 4.125% senior unsecured notes due October 2026.

 

At March 31, 2015, the weighted average interest rate on our:

·                  Notes and bonds payable of $3.8 billion (excluding unamortized original issuance discounts of $14.3 million) was 4.8%;

·                  Mortgages payable of $784.7 million (excluding net premiums totaling $14.6 million on these mortgages) was 5.0%;

·                  Credit facility outstanding borrowings of $370.0 million was 1.2%;

·                  Term loan outstanding borrowings of $70.0 million was 1.4%; and

·                  Combined outstanding notes, bonds, mortgages, term loan and credit facility borrowings of $5.02 billion was 4.5%.

 

-33-



Table of Contents

 

General and Administrative Expenses

General and administrative expenses remained at  $12.9 million for the first three months of 2015 and 2014.  Included in general and administrative expenses are acquisition transaction costs of $94,000 for the first three months of 2015 and $454,000 for the first three months of 2014. In April 2015, we had 131 employees, as compared to 118 employees in April 2014.

 

 

 

Three months ended

 

 

 

March 31,

 

Dollars in thousands

 

2015

 

2014

 

General and administrative expenses

 

$

12,862

 

$

12,886

 

Total revenue, including discontinued operations(1)

 

236,904

 

215,216

 

General and administrative expenses as a percentage of total revenue

 

5.4

%

6.0

%

 

(1) Excludes all tenant reimbursements revenue, as well as revenue included in discontinued operations and gain on sales.

 

Property Expenses (including tenant reimbursable expenses)

Property expenses consist of costs associated with unleased properties, non-net leased properties and general portfolio expenses, as well as contractually obligated reimbursements from tenants for recoverable real estate taxes and operating expenses. Expenses related to unleased properties and non-net leased properties include, but are not limited to, property taxes, maintenance, insurance, utilities, property inspections, bad debt expense and legal fees. General portfolio costs include, but are not limited to, insurance, legal, property inspections, and title search fees. At March 31, 2015, 86 properties were available for lease, as compared to 70 at December 31, 2014 and 73 at March 31, 2014.

 

Property expenses were $14.0 million (including $10.0 million reimbursable) in the first three months of 2015 and $10.6 million (including $6.4 million reimbursable) in the first three months of 2014. The increase in property expenses in the first three months of 2015 is primarily attributable to the increased portfolio size, which contributed to higher property taxes, maintenance and utilities, and bad debt expense along with higher contractually obligated reimbursements primarily due to our acquisitions during 2014 and the first three months of 2015.

 

Income Taxes

Income taxes were $1.1 million in the first three months of 2015 and 2014, respectively. These amounts are for city and state income and franchise taxes paid by Realty Income and its subsidiaries.

 

Discontinued Operations

During the first quarter of 2014, the Financial Accounting Standards Board issued guidance that changed the definition of discontinued operations by limiting discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have, or will have, a major effect on an entity’s operations and financial results.  We early adopted the requirements of this accounting pronouncement in the first quarter of 2014.  Starting with the first quarter of 2014, the results of operations for all qualifying disposals and properties classified as held for sale that were not previously reported in discontinued operations in our 2013 Annual Report on Form 10-K are presented within income from continuing operations on our consolidated statements of income

 

Operations from seven properties were classified as held for sale at March 31, 2015, and are included in income from continuing operations. For the three months ended March 31, 2014, we recorded income from discontinued operations of $3.1 million, or $0.01 per basic and diluted common share.

 

Provisions for Impairment

For the first three months of 2015, we recorded total provisions for impairment of $2.1 million on one sold property, one property classified as held for sale, and one property disposed of other than by sale. For the first three months of 2014, we recorded total provisions for impairment of $1.7 million on four sold properties. These properties were not previously classified as held for sale in financial statements issued prior to the date of adoption of ASU 2014-08; accordingly, the provisions for impairment are included in income from continuing operations on our consolidated statement of income for the three months ended March 31, 2015 and March 31, 2014, respectively.

 

-34-



Table of Contents

 

Gain on Sales of Real Estate

During the first three months of 2015, we sold nine investment properties for $22.3 million, which resulted in a gain of $7.2 million.  The results of operations for these properties are presented within continuing operations.

 

During the first three months of 2014, Realty Income sold 11 investment properties for $12.7 million, which resulted in a gain of $3.9 million. Only the results of operations specifically related to the properties classified as held for sale at December 31, 2013 and sold during the first three months of 2014 have been reclassified as discontinued operations.

 

During the first three months of 2015, Crest did not sell any properties.  During the first three months of 2014, Crest sold one property for $820,000, which did not result in a gain. The results of operations for this property have been reclassified as discontinued operations.

 

Preferred Stock Dividends

Preferred stock dividends totaled $6.8 million in the first three months of 2015 and $10.5 million in the first three months of 2014.

 

Net Income Available to Common Stockholders

Net income available to common stockholders was $60.5 million in the first three months of 2015, compared to $47.2 million in the first three months of 2014, an increase of $13.3 million. On a diluted per common share basis, net income available to common stockholders was $0.27 in the first three months of 2015, as compared to $0.23 in the first three months of 2014, an increase of $0.04, or 17.4%.

 

The calculation to determine net income available to common stockholders includes gains from the sale of properties. The amount of gains varies from period to period based on the timing of property sales and can significantly impact net income available to common stockholders.

 

Gains from the sale of properties during the first three months of 2015 were $7.2 million, as compared to gains from the sale of properties of $3.9 million during the first three months of 2014.

 

-35-



Table of Contents

 

FUNDS FROM OPERATIONS AVAILABLE TO COMMON STOCKHOLDERS (FFO)

 

In the first three months of 2015, our FFO increased by $18.4 million, or 13.7%, to $152.9 million, compared to $134.5 million in the first three months of 2014.  On a diluted per common share basis, FFO was $0.68 in the first three months of 2015, compared to $0.65 in the first three months of 2014, an increase of $0.03, or 4.6%.

 

The following is a reconciliation of net income available to common stockholders (which we believe is the most comparable GAAP measure) to FFO. Also presented is information regarding distributions paid to common stockholders and the weighted average number of common shares used for the basic and diluted computation per share (dollars in thousands, except per share amounts):

 

 

 

Three months ended

 

 

 

March 31,

 

 

 

2015

 

2014

 

Net income available to common stockholders

 

$

60,494

 

$

47,179

 

Depreciation and amortization, continuing operations

 

98,037

 

89,970

 

Depreciation of furniture, fixtures and equipment

 

(185

)

(91

)

Provisions for impairment on investment properties, continuing operations

 

2,087

 

1,683

 

Gain on sales of investment properties:

 

 

 

 

 

Continuing operations

 

(7,218

)

(1,271

)

Discontinued operations

 

-

 

(2,607

)

FFO adjustments allocable to noncontrolling interests

 

(315