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Realty Income 10-K 2009
ric10k_2008yr.htm



REALTY INCOME CORPORATION LOGO
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC  20549

FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2008
 
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
 
(IRS Employer
Incorporation or Organization)
 
Identification Number)
 
600 La Terraza Boulevard, Escondido, California  92025-3873
(Address of Principal Executive Offices)
 
Registrant’s telephone number, including area code: (760) 741-2111
 
Securities registered pursuant to Section 12 (b) of the Act:
 
   
Name of Each Exchange
Title of Each Class
 
On Which Registered
Common Stock, $1.00 Par Value
Class D Preferred Stock, $1.00 Par Value
Class E Preferred Stock, $1.00 Par Value
 
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
 
Securities registered pursuant to Section 12 (g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES x     NO o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  YES o     NO x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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

At June 30, 2008, the aggregate market value of the Registrant’s shares of common stock, $1.00 par value, held by non-affiliates of the Registrant was $2.2 billion, at the New York Stock Exchange (“NYSE”) closing price of $22.76.

At February 9, 2009, the number of shares of common stock outstanding was 104,319,051, the number of Class D preferred stock outstanding was 5,100,000 and the number of Class E preferred stock outstanding was 8,800,000.

DOCUMENTS INCORPORATED BY REFERENCE

Part III, Items 10, 11, 12, 13 and 14 incorporate by reference certain specific portions of the definitive Proxy Statement for Realty Income Corporation’s Annual Meeting to be held on May 12, 2009, to be filed pursuant to Regulation 14A. Only those portions of the proxy statement which are specifically incorporated by reference herein shall constitute a part of this annual report.




Index to Form 10-K

PART I
 
Page
 
Item 1:
     
 
The Company                                                                                           
   
2
 
 
Recent Developments                                                                                           
    3  
 
Distribution Policy                                                                                           
    5  
 
Business Philosophy and Strategy                                                                                           
    6  
 
Properties                                                                                           
    11  
 
Forward-Looking Statements                                                                                           
    16  
Item 1A:
Risk Factors                                                                                                  
    17  
Item 1B:
Unresolved Staff Comments                                                                                                  
    25  
Item 2:
Properties                                                                                                  
    25  
Item 3:
Legal Proceedings                                                                                                  
    26  
Item 4:
Submission of Matters to a Vote of Security Holders                                                                                                  
    26  
PART II
       
Item 5:
    26  
Item 6:
Selected Financial Data                                                                                                  
    27  
Item 7:
       
 
General                                                                                           
    28  
 
Liquidity and Capital Resources                                                                                           
    28  
 
Results of Operations                                                                                           
    33  
      41  
 
Impact of Inflation                                                                                           
    42  
 
Impact of Recent Accounting Pronouncements                                                                                           
    42  
Item 7A:
    42  
Item 8:
Financial Statements and Supplementary Data                                                                                                  
    44  
Item 9:
    70  
Item 9A:
Controls and Procedures                                                                                                  
    71  
Item 9B:
Other Information                                                                                                  
    72  
PART III
       
Item 10:
    72  
Item 11:
Executive Compensation                                                                                                  
    72  
Item 12:
    72  
Item 13:
    72  
Item 14:
Principal Accounting Fees and Services                                                                                                  
    72  
PART IV
       
Item 15:
Exhibits and Financial Statement Schedules                                                                                                  
    73  
    76  


 
PART I

Item 1:       Business

Realty Income Corporation, The Monthly Dividend Company®, is a Maryland corporation organized to operate as an equity real estate investment trust, or REIT.  Our primary business objective is to generate dependable monthly cash distributions from a consistent and predictable level of funds from operations, or FFO per share.  Our monthly distributions are supported by the cash flow from our portfolio of retail properties leased to regional and national retail chains.  We have in-house acquisition, leasing, legal, retail and real estate research, portfolio management and capital markets expertise. Over the past 39 years, Realty Income and its predecessors have been acquiring and owning freestanding retail properties that generate rental revenue under long-term lease agreements (primarily 15 to 20 years).

In addition, we seek to increase distributions to common stockholders and FFO per share through both active portfolio management and the acquisition of additional properties. Our portfolio management focus includes:
 
·  
Contractual rent increases on existing leases;
·  
Rent increases at the termination of existing leases, when market conditions permit; and
·  
The active management of our property portfolio, including re-leasing vacant properties, and selectively selling properties, thereby mitigating our exposure to certain tenants and markets.

In acquiring additional properties, we adhere to a focused strategy of primarily acquiring properties that are:
 
·  
Freestanding, single-tenant, retail locations;
·  
Leased to regional and national retail chains; and
·  
Leased under long-term, net-lease agreements.

At December 31, 2008, we owned a diversified portfolio:
 
·  
Of 2,348 retail properties;
·  
With an occupancy rate of 97.0%, or 2,278 properties occupied of the 2,348 properties in the portfolio;
·  
With only 70 properties available for lease;
·  
Leased to 119 different retail chains doing business in 30 separate retail industries;
·  
Located in 49 states;
·  
With over 19.1 million square feet of leasable space; and
·  
With an average leasable retail space per property of approximately 8,130 square feet.

Of the 2,348 properties in the portfolio, 2,337, or 99.5%, are single-tenant, retail properties and the remaining 11 are multi-tenant, distribution and office properties. At December 31, 2008, 2,268 of the 2,337 single-tenant properties were leased with a weighted average remaining lease term (excluding extension options) of approximately 11.9 years.

In addition, at December 31, 2008, our wholly-owned taxable REIT subsidiary, Crest Net Lease, Inc. (“Crest”), had an inventory of five properties with a carrying value of $6.0 million, which are classified as held for sale.  Crest was created to buy and sell properties, primarily to individual investors who are involved in tax-deferred exchanges under Section 1031 of the Internal Revenue Code of 1986, as amended (the “Tax Code”).  We anticipate Crest will not acquire any properties in 2009.

We typically acquire retail store properties under long-term leases with retail chain store operators. These transactions generally provide capital to owners of retail real estate and retail chains for expansion or other corporate purposes. Our acquisition and investment activities are concentrated in well-defined target markets and generally focus on retail chains providing goods and services that satisfy basic consumer needs.
 
 
Our net-lease agreements generally:
 
·  
Are for initial terms of 15 to 20 years;
·  
Require the tenant to pay minimum monthly rent and property operating expenses (taxes, insurance and maintenance); and
·  
Provide for future rent increases based on increases in the consumer price index (typically subject to ceilings), fixed increases, or to a lesser degree, additional rent calculated as a percentage of the tenants’ gross sales above a specified level.

We commenced operations as a REIT on August 15, 1994 through the merger of 25 public and private real estate limited partnerships. Each of the partnerships was formed between 1970 and 1989 for the purpose of acquiring and managing long-term, net-leased properties.

The eight senior officers of Realty Income owned 1.2% of our outstanding common stock with a market value of $25.9 million at February 9, 2009. The directors and eight senior officers of Realty Income, as a group, owned 2.5% of our outstanding common stock with a market value of $52.1 million at February 9, 2009.

Our common stock is listed on The New York Stock Exchange (“NYSE”) under the ticker symbol “O” with a cusip number of 756109-104. Our central index key number is 726728.

Our Class D cumulative redeemable preferred stock is listed on the NYSE under the ticker symbol “OprD” with a cusip number of 756109-609.

Our Class E cumulative redeemable preferred stock is listed on the NYSE under the ticker symbol “OprE” with a cusip number of 756109-708.

In February 2009, we had 69 permanent employees as compared to 75 permanent employees in February 2008.

We maintain an Internet website at www.realtyincome.com. On our website we make available, free of charge, copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after we electronically file these reports with the Securities and Exchange Commission, or SEC.  None of the information on our website is deemed to be part of this report.



Increases in Monthly Distributions to Common Stockholders
We continue our 39-year policy of paying distributions monthly.  Monthly distributions per share increased in January 2009 by $0.000625 to $0.14175.  The increase in January 2009 was our 45th consecutive quarterly increase and the 52nd increase in the amount of our dividend since our listing on the NYSE in 1994. In 2008, we paid three monthly cash distributions per share in the amount of $0.13675, three in the amount of $0.137375, two in the amount of $0.138, one in the amount of $0.1405 and three in the amount of $0.141125, totaling $1.66225. In December 2008 and January 2009, we declared distributions of $0.14175 per share, which were paid in January 2009 and will be paid in February 2009, respectively.

The monthly distribution of $0.14175 per share represents a current annualized distribution of $1.701 per share, and an annualized distribution yield of approximately 8.4% based on the last reported sale price of our common stock on the NYSE of $20.19 on February 9, 2009. Although we expect to continue our policy of paying monthly distributions, we cannot guarantee that we will maintain our current level of distributions, that we will continue our pattern of increasing distributions per share, or what our actual distribution yield will be in any future period.


Acquisitions During 2008
During 2008, Realty Income invested $189.6 million in 108 new retail properties and properties under development with an initial weighted average contractual lease rate of 8.7%. $181.4 million of these acquisitions occurred in the first quarter of 2008 while only $8.2 million was invested during the remainder of 2008.  These 108 properties are located in 14 states, contain over 714,000 leasable square feet, and are 100% leased with an average lease term of 20.6 years.  The 108 new properties acquired by Realty Income are net-leased to eight different retail chains in the following seven industries: automotive tire service, convenience store, drug store, financial services, motor vehicle dealership, restaurant and theater.  There were no acquisitions by Crest in 2008.

Our 2008 portfolio acquisitions were lower than in recent years primarily due to uncertainty in the commercial retail real estate market.  Property prices continued to decline and lease rates rose throughout 2008.  We continue to monitor the acquisition market carefully and will acquire properties for long-term investment when we believe the transactions are accretive to our shareholders.

The initial weighted average contractual lease rate is computed as estimated contractual net operating income (in a net-leased property this is equal to the base rent or, in the case of properties under development, the estimated base rent under the lease) for the first year of each lease, divided by the estimated total costs. Since it is possible that a tenant could default on the payment of contractual rent, we cannot assure you that the actual return on the funds invested will remain at the percentages listed above.

Investments in Existing Properties
In 2008, we capitalized costs of $2.8 million on existing properties in our portfolio, consisting of $956,000 for re-leasing costs and $1.5 million for building improvements.

$355 Million Acquisition Credit Facility
In May 2008, we entered into a new $355 million acquisition credit facility which replaced our existing $300 million acquisition credit facility that was scheduled to expire in October 2008.  The term of the new credit facility is for three years until May 2011, plus two, one-year extension options.  Under the new credit facility, our investment grade credit ratings provide for financing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 100 basis points with a facility fee of 27.5 basis points, for all-in drawn pricing of 127.5 basis points over LIBOR.  We also have other interest rate options available to us.

Issuance of Common Stock
In September 2008, we issued 2,925,000 shares of common stock at a price of $26.82 per share.  The net proceeds of $74.4 million were used, along with our available cash on hand, to repay the $100 million outstanding principal amount of our 8.25% Monthly Income Senior Notes (“2008 Notes”) in November 2008 and the $20 million outstanding principal amount of our 8% Notes (“2009 Notes”) in January 2009.

Note Redemptions
In November 2008, we redeemed the $100 million outstanding principal amount of our 2008 Notes.  In January 2009, we redeemed the $20 million outstanding principal amount of our 2009 Notes.  The 2008 Notes and 2009 Notes were redeemed at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest. We now have no debt maturities until 2013.

Retirement of Chairman of the Board of Directors
William E. Clark, our previous non-executive chairman, retired from the Board of Directors effective February 10, 2009.  Our Corporate Governance and Nominating Committee recommended, and the Board of Directors elected, Donald R. Cameron as the new non-executive chairman effective upon Mr. Clark’s retirement.  Mr. Cameron has served on Realty Income's Board of Directors since 1994, and has been Realty Income's lead independent director since May 2004.
 
 
Net Income Available to Common Stockholders
Net income available to common stockholders was $107.6 million in 2008 versus $116.2 million in 2007, a decrease of $8.6 million. On a diluted per common share basis, net income was $1.06 per share in 2008 as compared to $1.16 per share in 2007.
 
The calculation to determine net income available to common stockholders includes gains from the sales 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.

The gain recognized during 2008 from the sales of investment properties and from the additional proceeds received from a sale of excess land was $13.6 million, as compared to a $3.6 million gain recognized from the sales of investment properties and excess land during 2007.

Funds from Operations (FFO)
In 2008, our FFO decreased by $4.2 million, or 2.2%, to $185.5 million versus $189.7 million in 2007.  On a diluted per common share basis, FFO was $1.83 in 2008 compared to $1.89 in 2007, a decrease of $0.06, or 3.2%.

See our discussion of FFO in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this annual report, which includes a reconciliation of net income available to common stockholders to FFO.

Crest’s Property Sales
During 2008, Crest sold 25 properties from its inventory for an aggregate of $50.7 million, which resulted in a gain of $4.6 million.  Crest’s gains are included in “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statements of income.

Crest’s Property Inventory
Crest’s had an inventory of five properties with a carrying value of $6.0 million at December 31, 2008, which is included in “real estate held for sale, net” on our consolidated balance sheet.



Distributions are paid monthly to our common, Class D preferred and Class E preferred stockholders if, and when, declared by our Board of Directors.

In order to maintain our tax 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 REIT taxable income (determined without regard to the dividends paid deduction and excluding net capital gains), and we are subject to income tax to the extent we distribute less than 100% of our REIT taxable income (including net capital gains). In 2008, our cash distributions totaled $193.9 million, or approximately 122.7% of our estimated REIT taxable income of $158.0 million. Our estimated REIT taxable income reflects non-cash deductions for depreciation and amortization.  Our estimated REIT taxable income is presented to show our compliance with REIT distribution requirements and is not a measure of our liquidity or performance.

We intend to continue to make distributions to our stockholders that are sufficient to meet this distribution requirement and that will reduce our exposure to income taxes. Our 2008 cash distributions to common stockholders totaled $169.7 million, representing 91.5% of our funds from operations available to common stockholders of $185.5 million.

The Class D preferred stockholders receive cumulative distributions at a rate of 7.375% per annum on the $25 per share liquidation preference (equivalent to $1.84375 per annum per share).  The Class E preferred stockholders receive cumulative distributions at a rate of 6.75% per annum on the $25 per share liquidation preference (equivalent to $1.6875 per annum per share).
 
Future distributions will be at the discretion of our Board of Directors and will depend on, among other things, our results of operations, FFO, cash flow from operations, financial condition and capital requirements, the annual distribution requirements under the REIT provisions of the Tax Code, 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 deterioration in our results of operations or financial condition, 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 tax rate. The maximum tax rate of non-corporate taxpayers for “qualified dividend income” has generally been reduced to 15% (until it “sunsets” or reverts to the provisions of prior law, which under current law will occur with respect to taxable years beginning after December 31, 2010). In general, dividends payable by REITs are not eligible for the reduced tax rate on corporate dividends, except to the extent the REIT’s dividends are attributable to dividends received from taxable corporations (such as our taxable REIT subsidiary, Crest), 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) or, as discussed above, dividends properly designated by us as “capital gain dividends.” Distributions in excess of earnings and profits generally will be treated as a non-taxable reduction in the stockholders’ basis in their stock. Distributions above that basis, generally, will be taxable as a capital gain to stockholders who hold their shares as a capital asset. Approximately 18.8% of the distributions to our common stockholders, made or deemed to have been made in 2008, were classified as a return of capital for federal income tax purposes. We are unable to predict the portion of future distributions that may be classified as a return of capital.



Investment Philosophy
We believe that owning an actively managed, diversified portfolio of retail properties under long-term, net leases produces consistent and predictable income.  Net leases typically require the tenant to be responsible for monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, tenants are typically responsible for future rent increases based on increases in the consumer price index (typically subject to ceilings), fixed increases or, to a lesser degree, 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 leases, coupled with the tenant’s responsibility for property expenses, 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.

Investment Strategy
In identifying new properties for acquisition, our focus is generally on providing capital to retail chain owners and operators by acquiring, then leasing back, retail store locations. We categorize retail tenants as: 1) venture market, 2) middle market, and 3) upper market. Venture companies typically offer a new retail concept in one geographic region of the country and operate between five and 50 retail locations. Middle market retail chains typically have 50 to 500 retail locations, operations in more than one geographic region, have been successful through one or more economic cycles, and have a proven, replicable concept. The upper market retail chains typically consist of companies with 500 or more locations, operating nationally, in a proven, mature retail concept. Upper market retail chains generally have strong operating histories and access to several sources of capital.
 
We primarily focus on acquiring properties leased to middle market retail chains that we believe are attractive for investment because:

·  
They generally have overcome many of the operational and managerial obstacles that can adversely affect venture retailers;
·  
They typically require capital to fund expansion but have more limited financing options than upper market retail chains;
·  
They generally have provided us with attractive risk-adjusted returns over time since their financial strength has, in many cases, tended to improve as their businesses have matured;
·  
Their relatively large size allows them to spread corporate expenses across a greater number of stores; and
·  
Middle market retailers typically have the critical mass to survive if a number of locations are closed due to underperformance.

We also focus on, and have selectively made investments in, properties of upper market retail chains. We believe upper market retail chains can be attractive for investment because:
 
·  
They typically are of a higher credit quality;
·  
They usually are larger public and private retailers with more commonly recognized brand names;
·  
They utilize a larger building ranging in size from 10,000 to 50,000 square feet; and
·  
They are able to grow because access to capital facilitates larger transaction sizes.

While our investment strategy focuses primarily on acquiring properties leased to middle and upper market retail chains, we also selectively seek investment opportunities with venture market retail chains. Periodically, venture market opportunities arise where we feel that the real estate used by the tenant is high quality and can be purchased at favorable prices. To meet our stringent investment standards, however, venture retail companies must have a well-defined retailing concept and strong financial prospects. These opportunities are examined on a case by case basis and we are highly selective in making investments in this area.

Historically, our investment focus has been on retail industries that have a service component because we believe the lease revenue from these types of businesses is more stable. Because of this investment focus, for the quarter ended December 31, 2008, approximately 83.2% of our rental revenue was derived from retailers with a service component in their business. Furthermore, we believe these service-oriented businesses would be difficult to duplicate over the Internet and that our properties continue to perform well relative to competition from Internet businesses.

Credit Strategy
We generally provide sale-leaseback financing to less than investment grade retail chains.  We typically acquire and lease back properties to regional and national retail chains and believe that within this market we can achieve an attractive risk-adjusted return on the financing we provide to retailers.  Since 1970, our overall weighted average occupancy rate at the end of each year has been 98.4%, and the occupancy rate at the end of each year has never been below 97%.

We believe the principal financial obligations of most retailers 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 retail business, we believe the risk of default on a retailers’ lease obligations is less than the retailers’ unsecured general obligations. It has been our experience that since retailers must retain their profitable retail locations in order to survive, in the event of reorganization they are less likely to reject a lease for a profitable location because this would terminate their right to use the property. Thus, as the property owner, we believe we will fare better than unsecured creditors of the same retailer 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 the real estate leases can be further mitigated by monitoring the performance of the retailers’ individual unit locations and considering whether to sell locations that are weaker performers.
 
In order to qualify for inclusion in our portfolio, new property acquisitions must meet stringent investment and credit requirements. The properties must generate attractive current yields and the tenant must meet our credit profile.  We have established a three-part analysis that examines each potential investment based on:
 
·  
Industry, company, market conditions and credit profile;
·  
Store profitability, if profitability data is available; and
·  
Overall real estate characteristics, including property value and comparative rental rates.

The typical profile of companies whose properties have been approved for acquisition are those with 50 or more retail locations.  Generally the properties:

·  
Are located in highly visible areas;
·  
Have easy access to major thoroughfares; and
·  
Have attractive demographics.

Acquisition Strategy
We seek to invest in industries in which several, well-organized, regional and national retail chains are capturing market share through service, quality control, economies of scale, advertising and the selection of prime retail locations. We execute our acquisition strategy by acting as a source of capital to regional and national retail chain store owners and operators, doing business in a variety of industries, by acquiring and leasing back retail store locations. We undertake thorough research and analysis to identify appropriate industries, tenants and property locations for investment. Our research expertise is instrumental to uncovering net-lease opportunities in markets where our real estate financing program adds value. In selecting real estate for potential investment, we generally seek to acquire properties that have the following characteristics:
 
·  
Freestanding, commercially-zoned property with a single tenant;
·  
Properties that are important retail locations for regional and national retail chains;
·  
Properties that we deem to be profitable for the retailers;
·  
Properties that are located within attractive demographic areas relative to the business of their tenants, with high visibility and easy access to major thoroughfares; 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 rent increases.

Portfolio 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 its credit quality. Our executives review industry research, tenant research, property due diligence and significant portfolio management activities. This monitoring typically includes regular review and analysis of:
 
·  
The performance of various retail industries; and
·  
The operation, management, business planning and financial condition of the tenants.

We have an active portfolio 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, or extend our average remaining lease term. At December 31, 2008, we classified real estate with a carrying amount of $6.7 million as held for sale on our balance sheet, which includes $6.0 million for properties owned by Crest.  Additionally, we anticipate selling investment properties in our portfolio that have not yet been specifically identified, from which we anticipate receiving between $10 million and $35 million in proceeds during the next 12 months.  We intend to invest these proceeds into new property acquisitions. However, we cannot guarantee that we will sell properties during the next 12 months.
 
Universal Shelf Registration
In April 2006, we filed a shelf registration statement with the SEC, which is effective for a term of three years.  In accordance with the SEC rules, the amount of securities to be issued pursuant to this shelf registration statement was not specified when it was filed.  The securities covered by this registration statement include common stock, preferred stock, debt securities, or any combination of such securities.  We may periodically offer one or more of these securities in amounts, prices and on terms to be announced when and if the 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.  There is no specific limit to the dollar amount of new securities that can be issued under this shelf registration before it expires in April 2009, and our common stock, preferred stock and notes issued after April 2006 were all issued pursuant to this universal shelf registration statement.  Our plan is to file a new shelf registration statement prior to April 2009, when our existing shelf registration statement expires.

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 February 9, 2009, our total outstanding borrowings were $1.35 billion of senior unsecured notes, or approximately 35.5% of our total market capitalization of $3.80 billion. We had no borrowings on our $355 million credit facility.

We define our total market capitalization at February 9, 2009 as the sum of:
 
·  
Shares of our common stock outstanding of 104,319,051 multiplied by the last reported sales price of our common stock on the NYSE of $20.19 per share on February 9, 2009, or $2.11 billion;
·  
Aggregate liquidation value (par value of $25 per share) of the Class D preferred stock of $127.5 million;
·  
Aggregate liquidation value (par value of $25 per share) of the Class E preferred stock of $220 million; and
·  
Outstanding notes of $1.35 billion.

Historically, we have met our long-term capital needs through the issuance of 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 from time to time. 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 terms that are acceptable to us.

$355 Million Acquisition Credit Facility
In May 2008, we entered into a new $355 million revolving, unsecured credit facility which replaced our existing $300 million acquisition credit facility that was scheduled to expire in October 2008.  The term of the new credit facility is for three years until May 2011, plus two, one-year extension options.  Under the new credit facility, our investment grade credit ratings provided for financing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 100 basis points with a facility fee of 27.5 basis points, for all-in drawn pricing of 127.5 basis points over LIBOR.  We also have other interest rate options available to us.  At February 9, 2009, we had a borrowing capacity of $355 million available on our new credit facility and no outstanding balance.

We expect to use our credit facility to acquire additional retail properties and for other corporate purposes.  Any additional borrowings will increase our exposure to interest rate risk.  We have the right to request an increase in the borrowing capacity of the credit facility up to $100 million, to a total borrowing capacity of $455 million.  Any increase in the borrowing capacity is subject to the approval of our credit facility’s lending banks.


We use our credit facility for the short-term financing of new property acquisitions. When outstanding borrowings under the credit facility reach a certain level (generally in the range of $100 million to $200 million) and 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, convertible preferred stock, debt securities or convertible 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 refinancing will enable us to issue equity or debt securities upon acceptable terms.

Credit Agency Ratings
We are currently assigned investment grade corporate credit ratings on our senior unsecured notes.  Fitch Ratings has assigned a rating of BBB+, Moody’s Investors Service has assigned a rating of Baa1 and Standard & Poor’s Ratings Group has assigned a rating of BBB to our senior notes.  All of these ratings have “stable” outlooks.

We have also been assigned credit ratings on our preferred stock. Fitch Ratings has assigned a rating of BBB, Moody’s has assigned a rating of Baa2 and Standard & Poor’s has assigned a rating of BB+ to our preferred stock.  All of these ratings have “stable” outlooks.

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.

Mortgage Debt
We have no mortgage debt on any of our properties.

No Off-Balance Sheet Arrangements or Unconsolidated Investments
We have no unconsolidated or off-balance sheet investments in “variable interest entities” or off-balance sheet financing, nor do we engage in trading activities involving energy or commodity contracts or other derivative instruments.

As we have no joint ventures, off-balance sheet entities, or mandatory redeemable preferred stock, our financial position or results of operations are currently not affected by Financial Accounting Standards Board Interpretation No. 46R, Consolidation of Variable Interest Entities and Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.

Competitive Strategy
We believe that to successfully pursue our investment philosophy and strategy, we must seek to maintain the following competitive advantages:

·  
Size and Type of Investment Properties:  We believe smaller ($500,000 to $10,000,000) net-leased retail properties represent an attractive investment opportunity in today’s real estate environment. Due to the complexities of acquiring and managing a large portfolio of relatively small assets, we believe these types of properties have not experienced significant institutional ownership interest or the corresponding yield reduction experienced by larger income-producing properties. We believe the less intensive day-to-day property management required by net-lease agreements, coupled with the active management of a large portfolio of smaller properties, is an effective investment strategy. The tenants of our freestanding retail properties generally provide goods and services that satisfy basic consumer needs. In order to grow and expand, they generally need capital. Since the acquisition of real estate is typically the single largest capital expenditure of many of these retailers, our method of purchasing the property and then leasing it back, under a net-lease arrangement, allows the retail chain to free up capital.

 
·  
Investment in New Retail Industries:  Though we specialize in single-tenant properties, we will seek to further diversify our portfolio among a variety of retail industries. We believe diversification will allow us to invest in retail industries that currently are growing and have characteristics we find attractive. These characteristics include, but are not limited to, retail industries that are dominated by local store operators where regional and national chain store operators can increase market share and dominance by consolidating local operators and streamlining their operations, as well as capitalizing on major demographic shifts in a population base.

·  
Diversification:  Diversification of the portfolio by retail industry type, tenant, and geographic location is key to our objective of providing predictable investment results for our stockholders, therefore further diversification of our portfolio is a continuing objective. At December 31, 2008, our retail property portfolio consisted of 2,348 properties located in 49 states, leased to 119 retail chains doing business in 30 industry segments. Each of the 30 industry segments, represented in our property portfolio, individually accounted for no more than 20.8% of our rental revenue for the quarter ended December 31, 2008.

·  
Management Specialization:  We believe that our management’s specialization in single-tenant retail properties, operated under net-lease agreements, is important to meeting our objectives. We plan to maintain this specialization and will seek to employ and train high-quality professionals in this specialized area of real estate ownership, finance and management.

·  
Technology:  We intend to stay at the forefront of technology in our efforts to efficiently and economically carry out our operations. We maintain sophisticated information systems that allow us to analyze our portfolio’s performance and actively manage our investments. We believe that technology and information-based systems will play an increasingly important role in our competitiveness as an investment manager and source of capital to a variety of industries and tenants.



At December 31, 2008, we owned a diversified portfolio:

·  
Of 2,348 retail properties;
·  
With an occupancy rate of 97.0%, or 2,278 properties occupied of the 2,348 properties in the portfolio;
·  
With only 70 properties available for lease;
·  
Leased to 119 different retail chains doing business in 30 separate retail industries;
·  
Located in 49 states;
·  
With over 19.1 million square feet of leasable space; and
·  
With an average leasable retail space per property of approximately 8,130 square feet.

In addition to our real estate portfolio, our subsidiary, Crest had an inventory of five properties located in five states at December 31, 2008. These properties have a carrying value of $6.0 million and are classified as held for sale.

At December 31, 2008, 2,268 of our 2,348 retail properties were leased under net-lease agreements. A net lease typically requires the tenant to be responsible for minimum monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, our tenants are typically responsible for future rent increases based on increases in the consumer price index (typically subject to ceilings), fixed increases or, to a lesser degree, additional rent calculated as a percentage of the tenants’ gross sales above a specified level.

Our net-leased retail properties primarily are leased to regional and national retail chain store operators. Most buildings are single-story structures with adequate parking on site to accommodate peak retail traffic periods. The properties tend to be on major thoroughfares with relatively high traffic counts, adequate access and proximity to a sufficient population base to constitute a suitable market or trade area for the retailer’s business.
 
Industry Diversification
The following table sets forth certain information regarding Realty Income’s property portfolio (excluding properties owned by Crest) classified according to the business of the respective tenants, expressed as a percentage of our total rental revenue:
   
Percentage of Rental Revenue(1)
 
   
For the Quarter
   
For the Years Ended
 
 
Industries
 
Ended
December 31,
2008
   
Dec 31,
2008
   
Dec 31,
2007
   
Dec 31,
2006
   
Dec 31,
2005
   
Dec 31,
2004
   
Dec 31,
2003
 
Apparel stores
    1.1 %     1.1 %     1.2 %     1.7 %     1.6 %     1.8 %     2.1 %
Automotive collision services
    1.0       1.0       1.1       1.3       1.3       1.0       0.3  
Automotive parts
    1.6       1.6       2.1       2.8       3.4       3.8       4.5  
Automotive service
    4.7       4.8       5.2       6.9       7.6       7.7       8.3  
Automotive tire services
    6.8       6.7       7.3       6.1       7.2       7.8       3.1  
Book stores
    0.2       0.2       0.2       0.2       0.3       0.3       0.4  
Business services
    *       *       0.1       0.1       0.1       0.1       0.1  
Child care
    7.5       7.6       8.4       10.3       12.7       14.4       17.8  
Consumer electronics
    0.8       0.8       0.9       1.1       1.3       2.1       3.0  
Convenience stores
    16.4       15.8       14.0       16.1       18.7       19.2       13.3  
Crafts and novelties
    0.3       0.3       0.3       0.4       0.4       0.5       0.6  
Distribution and office
    1.0       1.0       0.6       --       --       --       --  
Drug stores
    4.2       4.1       2.7       2.9       2.8       0.1       0.2  
Entertainment
    1.2       1.2       1.4       1.6       2.1       2.3       2.6  
Equipment rental services
    0.2       0.2       0.2       0.2       0.4       0.3       0.2  
Financial services
    0.3       0.2       0.2       0.1       0.1       0.1       --  
General merchandise
    0.8       0.8       0.7       0.6       0.5       0.4       0.5  
Grocery stores
    0.7       0.7       0.7       0.7       0.7       0.8       0.4  
Health and fitness
    5.7       5.6       5.1       4.3       3.7       4.0       3.8  
Home furnishings
    2.6       2.4       2.6       3.1       3.7       4.1       4.9  
Home improvement
    1.8       1.9       2.1       3.4       1.1       1.0       1.1  
Motor vehicle dealerships
    3.1       3.1       3.1       3.4       2.6       0.6       --  
Office supplies
    1.0       1.0       1.1       1.3       1.5       1.6       1.9  
Pet supplies and services
    0.9       0.8       0.9       1.1       1.3       1.4       1.7  
Private education
    0.8       0.8       0.8       0.8       0.8       1.1       1.2  
Restaurants
    20.8       21.8       21.2       11.9       9.4       9.7       11.8  
Shoe stores
    --       --       --       --       0.3       0.3       0.9  
Sporting goods
    2.3       2.3       2.6       2.9       3.4       3.4       3.8  
Theaters
    9.1       9.0       9.0       9.6       5.2       3.5       4.1  
Travel plazas
    0.2       0.2       0.2       0.3       0.3       0.4       0.3  
Video rental
    1.0       1.1       1.7       2.1       2.5       2.8       3.3  
Other
    1.9       1.9       2.3       2.7       3.0       3.4       3.8  
Totals
    100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %
 
 
* Less than 0.1%
 
(1)
Includes rental revenue for all properties owned by Realty Income at the end of each period presented, including revenue from properties reclassified as discontinued operations.


Service Category Diversification
The following table sets forth certain information regarding the properties owned by Realty Income (excluding properties owned by Crest) at December 31, 2008, classified according to the retail business types and the level of services they provide (dollars in thousands):
Industry
 
Number of
Properties
   
Rental Revenue for the Quarter Ended December 31, 2008(1)
   
Percentage of
Rental
Revenue
 
Tenants Providing Services
                 
Automotive collision services
    13     $ 852       1.0 %
Automotive service
    235       3,908       4.7  
Child care
    263       6,201       7.5  
Entertainment
    8       999       1.2  
Equipment rental services
    3       158       0.2  
Financial services
    13       209       0.3  
Health and fitness
    26       4,685       5.7  
Private education
    7       631       0.8  
Theaters
    34       7,507       9.1  
Other
    9       1,557       1.9  
      611       26,707       32.4  
Tenants Selling Goods and Services
                 
Automotive parts (with installation)
    26       510       0.6  
Automotive tire services
    155       5,647       6.8  
Business services
    1       13       *  
Convenience stores
    574       13,518       16.4  
Distribution and office
    3       847       1.0  
Home improvement
    3       108       0.1  
Motor vehicle dealerships
    21       2,603       3.1  
Pet supplies and services
    10       666       0.8  
Restaurants
    642       17,217       20.8  
Travel plazas
    1       187       0.2  
Video rental
    32       829       1.0  
      1,468       42,145       50.8  
Tenants Selling Goods
                       
Apparel stores
    6       902       1.1  
Automotive parts
    51       842       1.0  
Book stores
    2       156       0.2  
Consumer electronics
    13       686       0.8  
Crafts and novelties
    5       242       0.3  
Drug stores
    51       3,481       4.2  
General merchandise
    33       694       0.8  
Grocery stores
    9       577       0.7  
Home furnishings
    44       2,127       2.6  
Home improvement
    29       1,420       1.7  
Office supplies
    10       788       1.0  
Pet supplies
    2       43       0.1  
Sporting goods
    14       1,877       2.3  
      269       13,835       16.8  
Totals
    2,348     $ 82,687       100.0 %

 
* Less than 0.1%
 
(1)
Includes rental revenue for all properties owned by Realty Income at December 31, 2008, including revenue from properties reclassified as discontinued operations of $44.
 
Lease Expirations
The following table sets forth certain information regarding Realty Income’s property portfolio (excluding properties owned by Crest) regarding the timing of the lease term expirations (excluding extension options) on our 2,268 net leased, single-tenant retail properties as of December 31, 2008 (dollars in thousands):

   
Total Portfolio
   
Initial Expirations(3)
   
Subsequent Expirations(4)
 
 
 
 
 
Year
 
 
Total
Number of Leases Expiring(1)
   
Rental
Revenue
 for the
Quarter Ended December 31, 2008(2)
   
 
% of
Total Rental Revenue
   
 
 
Number of
 Leases Expiring
   
Rental
 Revenue
for the
Quarter Ended December 31, 2008
   
 
% of
Total Rental Revenue
   
 
 
Number of Leases Expiring
   
Rental
 Revenue
for the
Quarter Ended December 31, 2008
   
 
% of
Total Rental Revenue
 
2009
    148     $ 3,084       3.9 %     36     $ 787       1.0 %     112     $ 2,297       2.9 %
2010
    102       2,197       2.7       48       1,227       1.5       54       970       1.2  
2011
    105       3,137       3.9       57       2,055       2.6       48       1,082       1.3  
2012
    113       2,681       3.3       75       1,864       2.3       38       817       1.0  
2013
    140       5,316       6.7       99       4,329       5.4       41       987       1.3  
2014
    55       2,125       2.7       36       1,780       2.2       19       345       0.5  
2015
    108       2,857       3.6       85       2,318       2.9       23       539       0.7  
2016
    114       2,015       2.5       112       1,987       2.5       2       28       *  
2017
    49       1,894       2.4       41       1,745       2.2       8       149       0.2  
2018
    42       1,888       2.4       34       1,689       2.1       8       199       0.3  
2019
    100       4,856       6.1       94       4,526       5.7       6       330       0.4  
2020
    82       2,987       3.7       79       2,923       3.6       3       64       0.1  
2021
    170       7,503       9.4       169       7,448       9.3       1       55       0.1  
2022
    101       2,951       3.7       100       2,903       3.6       1       48       0.1  
2023
    245       7,754       9.7       243       7,680       9.6       2       74       0.1  
2024
    62       1,815       2.3       62       1,815       2.3       --       --       --  
2025
    70       5,466       6.9       66       5,398       6.8       4       68       0.1  
2026
    122       6,866       8.6       120       6,809       8.5       2       57       0.1  
2027
    152       4,622       5.8       151       4,605       5.8       1       17       *  
2028
    82       4,009       5.0       80       3,938       4.9       2       71       0.1  
2029
    45       1,099       1.4       45       1,099       1.4       --       --       --  
2030
    20       924       1.2       20       924       1.2       --       --       --  
2031
    27       649       0.8       27       649       0.8       --       --       --  
2032
    2       57       0.1       2       57       0.1       --       --       --  
2033
    7       422       0.5       7       422       0.5       --       --       --  
2034
    2       230       0.3       2       230       0.3       --       --       --  
2037
    2       354       0.4       2       354       0.4       --       --       --  
2043
    1       13       *       --       --       --       1       13       *  
Totals
    2,268     $ 79,771       100.0 %     1,892     $ 71,561       89.5 %     376     $ 8,210       10.5 %
 
* Less than 0.1%
 
(1)
Excludes ten multi-tenant properties and 70 vacant unleased properties, one of which is a multi-tenant property.  The lease expirations for properties under construction are based on the estimated date of completion of those properties.
(2)
Includes rental revenue of $44 from properties reclassified as discontinued operations and excludes revenue of $2,916 from ten multi-tenant properties and from 70 vacant and unleased properties at December 31, 2008.
(3)
Represents leases to the initial tenant of the property that are expiring for the first time.
(4)
Represents lease expirations on properties in the portfolio, which have previously been renewed, extended or re-tenanted.


State Diversification
The following table sets forth certain state-by-state information regarding Realty Income’s property portfolio (excluding properties owned by Crest) as of December 31, 2008 (dollars in thousands):
 
State
 
Number of
Properties
   
Percent
Leased
   
Approximate
Leasable
Square Feet
   
Rental Revenue for the Quarter Ended December 31, 2008(1)
   
Percentage of
Rental
Revenue
 
Alabama
    63       98 %