10-Q 1 riq311_10q.htm REALTY INCOME CORPORATION FORM 10-Q riq311_10q.htm





 
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 September 30, 2011, 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)
 
600 La Terraza Boulevard, Escondido, California  92025-3873
(Address of Principal Executive Offices)

Registrant's telephone number, including area code: (760) 741-2111

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 133,205,842 shares of common stock outstanding as of October 20, 2011.

 
 

 

REALTY INCOME CORPORATION
 

Form 10-Q
September 30, 2011

 

PART I.                   FINANCIAL INFORMATION
 
Page
 
Item 1:
     
 
Consolidated Balance Sheets                                                                                                
    2  
 
Consolidated Statements of Income                                                                                                
    3  
 
Consolidated Statements of Cash Flows                                                                                                
    4  
 
Notes to Consolidated Financial Statements                                                                                                
    5  
Item 2:
       
      18  
      19  
 
Recent Developments                                                                                                
    21  
 
Liquidity and Capital Resources                                                                                                
    24  
 
Results of Operations                                                                                                
    29  
      36  
 
Adjusted Funds from Operations Available to Common Stockholders (AFFO)                                                                                            
    37  
 
Property Portfolio Information                                                                                                
    38  
 
Impact of Inflation                                                                                                
    44  
 
Impact of Recent Accounting Pronouncements                                                                                                
    44  
 
Other Information                                                                                                
    44  
Item 3:
    44  
Item 4:
Controls and Procedures                                                                                                  
    45  
PART II.                   OTHER INFORMATION
       
Item 1A:
Risk Factors                                                                                                  
    46  
Item 2:
    46  
Item 6:
Exhibits                                                                                                  
    46  
 
    49  


FINANCIAL INFORMATION
 
Financial Statements
 
CONSOLIDATED BALANCE SHEETS
 
September 30, 2011 and December 31, 2010
(dollars in thousands, except per share data)
 
   
2011
   
2010
 
ASSETS
 
(unaudited)
       
Real estate, at cost:
           
Land
  $ 1,689,523     $ 1,520,413  
Buildings and improvements
    3,111,258       2,592,449  
Total real estate, at cost
    4,800,781       4,112,862  
Less accumulated depreciation and amortization
    (786,863 )     (711,615 )
Net real estate held for investment
    4,013,918       3,401,247  
Real estate held for sale, net
    4,158       3,631  
Net real estate
    4,018,076       3,404,878  
Cash and cash equivalents
    5,543       17,607  
Accounts receivable, net
    12,065       11,301  
Goodwill
    17,206       17,206  
Other assets, net
    221,884       84,598  
Total assets
  $ 4,274,774     $ 3,535,590  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Distributions payable
  $ 21,360     $ 19,051  
Accounts payable and accrued expenses
    34,538       47,019  
Other liabilities
    28,584       22,555  
Line of credit payable
    96,600       --  
Mortgages payable, net
    68,150       --  
Notes payable
    1,750,000       1,600,000  
Total liabilities
    1,999,232       1,688,625  
                 
Commitments and contingencies
               
                 
Stockholders' equity:
               
Preferred stock and paid in capital, par value $0.01 per share,
               
20,000,000 shares authorized, 13,900,000 shares issued
               
and outstanding in 2011 and 2010
    337,790       337,790  
Common stock and paid in capital, par value $0.01 per share,
               
200,000,000 shares authorized, 133,202,323 and 118,058,988
               
shares issued and outstanding as of September 30, 2011 and
               
December 31, 2010, respectively
    2,560,612       2,066,287  
Distributions in excess of net income
    (622,860 )     (557,112 )
Total stockholders' equity
    2,275,542       1,846,965  
Total liabilities and stockholders' equity
  $ 4,274,774     $ 3,535,590  
 
The accompanying notes to consolidated financial statements are an integral part of these statements.


CONSOLIDATED STATEMENTS OF INCOME

For the three and nine months ended September 30, 2011 and 2010
(dollars in thousands, except per share data)
(unaudited)
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
                         
REVENUE
                       
Rental
  $ 106,808     $ 86,749     $ 306,746     $ 251,237  
Other
    488       84       886       385  
Total revenue
    107,296       86,833       307,632       251,622  
                                 
EXPENSES
                               
Depreciation and amortization
    31,869       23,941       87,542       70,145  
Interest
    28,550       25,135       79,318       68,106  
General and administrative
    7,143       6,165       23,001       19,526  
Property
    1,698       1,742       5,102       5,324  
Income taxes
    367       335       1,102       890  
Total expenses
    69,627       57,318       196,065       163,991  
Income from continuing operations
    37,669       29,515       111,567       87,631  
Income from discontinued operations
    3,111       2,139       4,460       5,276  
Net income
    40,780       31,654       116,027       92,907  
Preferred stock cash dividends
    (6,063 )     (6,063 )     (18,190 )     (18,190 )
Net income available to common stockholders
  $ 34,717     $ 25,591     $ 97,837     $ 74,717  
                                 
Amounts available to common stockholders per common share:
                               
Income from continuing operations:
                               
Basic
  $ 0.25     $ 0.23     $ 0.75     $ 0.67  
Diluted
  $ 0.25     $ 0.23     $ 0.75     $ 0.67  
Net income:
                               
Basic
  $ 0.27     $ 0.25     $ 0.79     $ 0.72  
Diluted
  $ 0.27     $ 0.25     $ 0.79     $ 0.72  
                                 
Weighted average common shares outstanding:
                               
Basic
    126,376,201       103,830,029       123,921,317       103,781,108  
Diluted
    126,582,609       103,977,023       124,013,142       103,887,679  
 
The accompanying notes to consolidated financial statements are an integral part of these statements.


CONSOLIDATED STATEMENTS OF CASH FLOWS
 
For the nine months ended September 30, 2011 and 2010
(dollars in thousands)(unaudited)

   
2011
   
2010
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income
  $ 116,027     $ 92,907  
Adjustments to net income:
               
Depreciation and amortization
    87,542       70,145  
Income from discontinued operations
    (4,460 )     (5,276 )
Gain on sale of land
    (210 )     --  
Amortization of share-based compensation
    6,098       4,824  
Amortization of net premiums on mortgages payable
    (98 )     --  
Provision for impairment on real estate held for investment
    10       --  
Cash provided by discontinued operations:
               
Real estate
    773       2,055  
Collection of principal on notes receivable
    110       103  
Change in assets and liabilities:
               
Accounts receivable and other assets
    8,672       7,023  
Accounts payable, accrued expenses and other liabilities
    (15,217 )     (15,020 )
Net cash provided by operating activities
    199,247       156,761  
CASH FLOWS FROM INVESTING ACTIVITIES
               
Acquisition of income producing investment properties
    (766,148 )     (304,615 )
Proceeds from the sales of real estate:
               
Continuing operations
    783       --  
Discontinued operations
    11,692       15,294  
Restricted escrow deposits
    (2,830 )     (5,687 )
Net cash used in investing activities
    (756,503 )     (295,008 )
CASH FLOWS FROM FINANCING ACTIVITIES
               
Cash distributions to common stockholders
    (161,276 )     (134,700 )
Cash dividends to preferred stockholders
    (18,190 )     (18,190 )
Borrowings under line of credit
    378,100       408,700  
Payments on line of credit
    (281,500 )     (413,300 )
Principal payments on mortgages
    (138 )     --  
Proceeds from common stock offerings, net
    489,236       196,899  
Proceeds from bonds issued, net of financing costs of $9,923
    140,077       --  
Proceeds from notes issued, net of financing costs of $3,869
    --       246,131  
Proceeds from dividend reinvestment and stock purchase plan, net
    1,242       --  
Other items
    (2,359 )     (1,737 )
Net cash provided by financing activities
    545,192       283,803  
Net increase (decrease) in cash and cash equivalents
    (12,064 )     145,556  
Cash and cash equivalents, beginning of period
    17,607       10,026  
Cash and cash equivalents, end of period
  $ 5,543     $ 155,582  

For supplemental disclosures, see note 13.
 
The accompanying notes to consolidated financial statements are an integral part of these statements.

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011
(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 period presented. Readers of this quarterly report should refer to our audited consolidated financial statements for the year ended December 31, 2010, which are included in our 2010 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.

We report, in discontinued operations, the results of operations of properties that have either been disposed of or are classified as held for sale.  As a result of these discontinued operations, certain of the 2010 balances have been reclassified to conform to the 2011 presentation.

At September 30, 2011, we owned 2,600 properties, located in 49 states, containing over 26.8 million leasable square feet, along with three properties owned by our wholly-owned taxable REIT subsidiary, Crest Net Lease, Inc., or Crest.

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 have no unconsolidated or off-balance sheet investments in variable interest entities.

B.  We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code. We believe we have qualified and continue to qualify as a REIT. Under the REIT operating structure, we are permitted to deduct distributions paid to our stockholders and 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 the federal income taxes of Crest, which are included in discontinued operations. 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 $1.4 million at September 30, 2011 and $1.1 million at December 31, 2010.
 
   
September 30,
   
December 31,
 
D.  Other assets consist of the following (dollars in thousands) at:
 
2011
   
2010
 
Value of in-place and above market leases, net
  $ 150,124     $ 26,221  
Deferred bond financing costs, net
    22,729       14,203  
Notes receivable issued in connection with Crest property sales
    21,965       22,075  
Note receivable assumed in connection with 2011 acquisitions
    8,780       --  
Prepaid expenses
    8,236       8,431  
Restricted escrow deposits
    2,830       6,361  
Credit facility origination costs, net
    3,508       4,619  
Deferred financing costs on assumed mortgages payable, net
    835       --  
Corporate assets, net of accumulated depreciation and amortization
    739       827  
Other items
    2,138       1,861  
    $ 221,884     $ 84,598  
 
 
                 
E.  Distributions payable consist of the following declared
 
September 30,
   
December 31,
 
distributions (dollars in thousands) at:
    2011       2010  
Common stock distributions
  $ 19,339     $ 17,030  
Preferred stock dividends
    2,021       2,021  
    $ 21,360     $ 19,051  
                 
F.  Accounts payable and accrued expenses consist of the
 
September 30,
   
December 31,
 
following (dollars in thousands) at:
    2011       2010  
Bond interest payable
  $ 12,925     $ 33,240  
Accrued costs on properties under development
    5,023       420  
Other items
    16,590       13,359  
    $ 34,538     $ 47,019  

   
September 30,
   
December 31,
 
G.  Other liabilities consist of the following (dollars in thousands) at:
 
2011
   
2010
 
Rent received in advance
  $ 17,496     $ 14,564  
Value of in-place below-market leases, net
    6,600       3,452  
Security deposits
    4,488       4,539  
    $ 28,584     $ 22,555  

H. Goodwill is tested for impairment during the second quarter of each year as well as when events or circumstances occur indicating that our goodwill might be impaired. During our test for impairment of goodwill during the second quarters of 2011 and 2010, we determined that the estimated fair values of our reporting units exceeded their carrying values. We did not record any impairment on our existing goodwill in 2011 or 2010.

I.    Impact of Recent Accounting Pronouncements
 
In May 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update, or ASU, No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. Effective for periods beginning after December 15, 2011, ASU No. 2011-04 clarifies how a principal market is determined, addresses the fair value measurement of instruments with offsetting market or counterparty credit risks and the concept of valuation premise and highest and best use, extends the prohibition on blockage factors to all three levels of the fair value hierarchy, and requires additional disclosures. ASU No. 2011-04 will apply only to our disclosures in note 8 related to the fair value of assets and liabilities and is not expected to have a significant impact on our footnote disclosures.

In August 2011, the FASB issued ASU No. 2011-08, Intangibles - Goodwill and Other (Topic 350), which  is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Under the amendments in ASU No. 2011-08, an entity, through an assessment of qualitative factors, is not required to calculate the estimated fair value of a reporting unit, in connection with the two-step goodwill impairment test, unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. ASU No. 2011-08 will apply only to our disclosures in note 2 related to our annual goodwill impairment test.

J.   Par Value Change
 
In August 2011, we changed the par value of our common and preferred stock from $1.00 per share to $0.01 per share. This change did not have an impact on the amount of our total stockholders’ equity.


3.       Investments in Real Estate
 
We acquire the land, buildings and improvements that are necessary for the successful operations of retail and other commercial enterprises.

A.  During the first nine months of 2011, we invested $826.4 million in 125 new properties, and properties under development, with an initial weighted average contractual lease rate of 7.9%. The majority of the lease revenue from these properties will be generated from investment grade tenants. These 125 new properties, and properties under development, are located in 25 states, will contain over 5.5 million leasable square feet, and are 100% leased with an average lease term of 11.3 years. The initial weighted average contractual lease rate is computed by dividing the estimated aggregate base rent for the first year of each lease by the estimated total cost of the properties. Acquisition transaction costs of $1.1 million were recorded to general and administrative expense on our consolidated statement of income, for the nine months ended September 30, 2011.

Included in the $826.4 million invested, during the first nine months of 2011, are the following acquisitions:

(1)  
In March, we announced the signing of definitive purchase agreements to acquire 33 single-tenant retail, distribution, office and manufacturing properties for approximately $544 million.  Between March and August, we acquired 32 of the 33 properties for $524.8 million.  We anticipate that we will acquire the one remaining property during the fourth quarter of 2011.
(2)  
In August, we acquired 60 properties operating in the restaurant - quick service industry for $41.9 million, under long-term, triple net lease agreements.
(3)  
In September, we acquired six properties operating in the wholesale clubs industry for $156.1 million, under long-term, triple net lease agreements.
(4)  
In September, we acquired nine properties operating in the health and fitness industry for $63.2 million, under long-term, triple net lease agreements.
(5)  
The remaining 18 properties acquired totaled approximately $40.4 million and were acquired at various times during 2011.

Our acquisitions during the first nine months of 2011 were allocated as follows: $173.4 million to land, $528.3 million to buildings and improvements, $129.9 million to intangible assets and $5.2 million to intangible and assumed liabilities, which includes mortgage premiums of $957,000. Additionally, we assumed $8.8 million in notes receivable and $67.4 million in mortgages payable as a result of these acquisitions.  All of the acquisitions were cash purchases and there was no contingent consideration associated with these acquisitions.

For the nine months ended September 30, 2011, total revenues of $15.5 million and income from continuing operations of $5.1 million are included in the consolidated income statement from the properties acquired during the first nine months of 2011.

The following pro forma total revenue and income from continuing operations, for the first nine months of 2011 and 2010, assumes the 2011 property acquisitions took place on January 1, 2010 (in millions):
 
   
Total revenue
   
Income from
continuing operations
 
Supplemental pro forma for the nine months ended September 30, 2011(1)
  $ 342.1     $ 115.4  
Supplemental pro forma for the nine months ended September 30, 2010(1)
  $ 300.4     $ 92.3  
 
(1) This unaudited pro forma supplemental information does not purport to be indicative of what our operating results would have been had the acquisitions occurred on January 1, 2010, and may not be indicative of future operating results.  No material, non-recurring pro-forma adjustments were included in the calculation of this information.
 

In comparison, during the first nine months of 2010, we invested $302.9 million in 23 new properties with an initial weighted average contractual lease rate of 7.6%. These 23 properties are located in eight states, contain over 511,000 leasable square feet, and are 100% leased with an average lease term of 18.3 years. Acquisition transaction costs of $191,000 were recorded to general and administrative expense on our consolidated statement of income, for the nine months ended September 30, 2010.

During the first nine months of 2011, we capitalized costs of $3.0 million on existing properties in our portfolio, consisting of $1.3 million for re-leasing costs and $1.7 million for building and tenant improvements. In comparison, during the first nine months of 2010, we capitalized costs of $2.3 million on existing properties in our portfolio, consisting of $874,000 for re-leasing costs and $1.4 million for building and tenant improvements.

B.  Of the $826.4 million we invested, in the first nine months of 2011, approximately $573.1 million was used to acquire 93 properties with existing leases. Associated with these 93 properties, we recorded $107.6 million as the intangible value of the in-place leases, $22.3 million as the intangible value of above-market leases and $3.5 million as the intangible value of below-market leases. The value of the in-place and above-market leases is recorded to other assets on our consolidated balance sheet, and the value of the below-market leases is recorded to other liabilities on our consolidated balance sheet. The value of the in-place leases is amortized as depreciation and amortization expense, while the value of the above-market and below-market leases is amortized as rental revenue on our consolidated statements of income. All of these amounts are amortized over the life of the respective leases.

4.     Credit Facility

In December 2010, we entered into a $425 million revolving, unsecured credit facility that replaced our previous $355 million acquisition credit facility that was scheduled to expire in May 2011. The initial term of the credit facility expires in March 2014 and includes two, one-year extension options. Under this credit facility, our investment grade credit ratings provide for financing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 185 basis points with a facility commitment fee of 35 basis points, for all-in drawn pricing of 220 basis points 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. Our credit facility is unsecured and, accordingly, we have not pledged any assets as collateral for this obligation.

As a result of entering into our current credit facility, we incurred credit facility origination costs of $4.2 million that were classified as part of other assets on our consolidated balance sheet at December 31, 2010.  At September 30, 2011, the balance of these credit facility origination costs was $3.5 million, which is being amortized over the remaining term of the credit facility.

At September 30, 2011, we had a borrowing capacity of $328.4 million available on our credit facility and an outstanding balance of $96.6 million, as compared to zero borrowings at December 31, 2010. The average borrowing rate on our credit facility, during the first nine months of 2011, was 2.1% and, during the first nine months of 2010, was 1.3%. Our current and prior credit facilities are subject to various leverage and interest coverage ratio limitations. We are and have been in compliance with these covenants.


5.     Notes Payable

A.  
General
 
Our senior unsecured notes consisted of the following at September 30, 2011 and December 31, 2010, sorted by maturity date (dollars in millions):
   
September 30,   
2011   
   
December 31,   
 2010   
 
   5.375% notes, issued in March 2003 and due in March 2013
  $ 100     $ 100  
   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  
   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  
   5.875% bonds, $100 issued in March 2005 and $150 issued in June 2011, both due in March 2035
    250       100  
    $ 1,750     $ 1,600  

B.  
Re-opening of Unsecured Bonds due 2035
 
In June 2011, we re-opened our 5.875% senior unsecured bonds due 2035, or the 2035 Bonds, and issued $150.0 million in aggregate principal amount of these 2035 Bonds. The public offering price for the additional 2035 Bonds was 94.578% of the principal amount for an effective yield of 6.318%. Those 2035 Bonds constituted an additional issuance of, and a single series with, the $100 million in aggregate principal amount of the 2035 Bonds that we issued in March 2005. The net proceeds of approximately $140.1 million were used to fund property acquisitions.  Interest is paid semiannually on the 2035 Bonds.

C.  
Note Issuance
 
In June 2010, we issued $250.0 million in aggregate principal amount of 5.75% senior unsecured notes due January 2021, or the 2021 Notes. The public offering price for the 2021 Notes was 99.404% of the principal amount for an effective yield of 5.826%. The net proceeds of approximately $246.1 million from this offering were used to repay borrowings under our acquisition credit facility, which were incurred to finance the acquisition of our properties. Interest is paid semiannually on the 2021 Notes.
 
6.
Mortgages Payable
 
As part of the $826.4 million invested in new properties during the first nine months of 2011, we assumed $67.4 million of mortgages payable to third-party lenders. These mortgages are secured by the properties on which the debt was placed and are non-recourse. We expect to pay off the mortgages as soon as prepayment penalties and costs make it economically feasible to do so. We intend to continue our policy of primarily identifying property acquisitions that are free from mortgage indebtedness.

In aggregate, net premiums totaling $957,000 were recorded upon assumption of the mortgages at the time of the respective property acquisitions to account for above-market interest rates. Amortization of these net premiums is recorded as a reduction to interest expense over the remaining term of the respective notes, 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.

As a result of assuming these mortgages payable, we incurred deferred financing costs of $917,000 that were classified as part of other assets on our consolidated balance sheet at September 30, 2011.  The balance of these deferred financing costs at September 30, 2011, was $835,000, which is being amortized over the remaining term of each mortgage.


The following is a summary of our mortgages payable as of September 30, 2011 (principal balance, unamortized premiums (discounts) and mortgage payable balances in thousands):
 
 
 
 
Tenant Name
 
 Stated
 Interest
 Rate(1)
   
Effective
 Interest
 Rate
 
 
 
Maturity
 Date(2)
 
Remaining
Principal
 Balance(2)
   
Amortized
Premium
(Discount)
 Balance
   
 Mortgage   
 Payable   
 Balance   
 
Aviall Services, Inc. (3)
    6.25 %     4.96 %
 12/1/13   
  $ 12,512     $ 406     $ 12,918  
Aviall Services, Inc. (3)
    6.25 %     4.82 %
9/1/14   
    11,710       343       12,053  
T-Mobile USA, Inc.
    5.89 %     5.15 %
5/6/14   
    10,664       182       10,846  
MeadWestvaco Corporation
    4.73 %     4.89 %
6/10/15   
    23,625       (72 )     23,553  
Solae, LLC(3)(4)
    8.26 %     8.26 %
12/28/13   
    4,510       --       4,510  
Solae, LLC(3)(4)
    8.26 %     8.26 %
12/28/13   
    4,270       --       4,270  
                      $ 67,291     $ 859     $ 68,150  
 
 
(1) With the exception of the MeadWestvaco Corporation mortgage, the mortgages are at fixed interest rates.  The MeadWestvaco Corporation mortgage is at a floating variable interest rate calculated as the sum of the current 1 month LIBOR plus 4.50%, not to exceed an all-in interest rate of 5.5%.
 
(2) The mortgages require monthly payments, with a principal payment due at maturity.
 
(3) These are mortgages associated with one property occupied by the applicable tenant.
 
(4) As part of the assumption of these mortgages payable related to our acquisition of Solae, LLC, we also assumed an $8.8 million note receivable, upon which we will receive interest income at a stated rate of 8.14% through December 28, 2013.

7.     Issuance of Common Stock

In September 2011, we issued 6,300,000 shares of common stock at a price of $34.00 per share. After underwriting discounts and other offering costs of $10.6 million, the net proceeds of $203.6 million were used to repay borrowings under our acquisition credit facility, which were used to fund recent acquisitions.

In March 2011, we issued 8,625,000 shares of common stock at a price of $34.81 per share. After underwriting discounts and other offering costs of $14.6 million, the net proceeds of $285.6 million were used to fund property acquisitions.

8.     Fair Value of Financial Assets and Liabilities
 
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, and all liabilities, due to their short-term nature, except for our notes receivable issued in connection with property sales, mortgages payable and our senior notes payable, which are disclosed below (dollars in millions). The note receivable assumed in connection with an acquisition during the third quarter of 2011 was recorded at its estimated fair market value, which reflects the amount reported on our consolidated balance sheet.
 
   
Carrying value per
   
Estimated
 
At September 30, 2011
 
balance sheet
   
fair value
 
Notes receivable issued in connection with Crest property sales
  $ 22.0     $ 23.0  
Mortgages payable
  $ 68.2     $ 68.1  
Notes payable
  $ 1,750.0     $ 1,874.4  

   
Carrying value per
   
Estimated
 
At December 31, 2010
 
balance sheet
   
fair value
 
Notes receivable issued in connection with Crest property sales
  $ 22.1     $ 23.2  
Notes payable
  $ 1,600.0     $ 1,707.1  


The estimated fair value of our notes receivable, issued in connection with property sales, has been calculated by discounting the future cash flows using an interest rate based upon the current 5-year or 7-year Treasury yield curve, plus an applicable credit-adjusted spread. The notes receivable were issued in connection with the sale of three Crest properties. Payments to us on these notes receivable are current and no allowance for doubtful accounts has been recorded for them.

The estimated fair value of our mortgages payable has been calculated by discounting the future cash flows using an interest rate based upon the current 5-year Treasury yield curve, plus an applicable credit-adjusted spread.

The estimated fair value of our senior notes payable is based upon indicative market prices and recent trading activity of our notes payable.

9.     Gain on Sales of Investment Properties
 
During the third quarter of 2011, we sold 12 investment properties for $7.3 million, which resulted in a gain of $3.1 million. During the first nine months of 2011, we sold 21 investment properties for $11.7 million, which resulted in a gain of $4.3 million. The results of operations for these properties have been reclassified as discontinued operations. Additionally, during the third quarter of 2011, we sold excess land from two properties for $108,000, which resulted in a gain of $55,000. During the first nine months of 2011, we sold excess land from five properties for $783,000, which resulted in a gain of $210,000.  These gains are included in other revenue on our consolidated statements of income, for the three and nine months ended September 30, 2011, respectively, because this excess land was associated with properties that continue to be owned as part of our core operations.

In comparison, during the third quarter of 2010, we sold nine investment properties for a total of $8.9 million, which resulted in a gain of $1.9 million. During the first nine months of 2010, we sold 19 investment properties and excess land from one property for $16.7 million, which resulted in a gain of $4.3 million. The results of operations for these properties have been reclassified as discontinued operations.

10.     Discontinued Operations

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. An impairment is recorded 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 use in this analysis include: projected rental rates, capital expenditures and property sales capitalization rates. Additionally, a property classified as held for sale is carried at the lower of carrying cost or estimated fair value, less estimated cost to sell.

For the third quarter of 2011, we recorded a provision for impairment of $158,000 on one property, which was sold during the third quarter of 2011. For the third quarter of 2010, we recorded a provision for impairment of $84,000 on one property, which was sold during the third quarter of 2010.

For the first nine months of 2011, we recorded provisions for impairment of $368,000 on four properties, three of which were sold in the first nine months of 2011 and one of which was classified as held for sale at September 30, 2011. For the first nine months of 2010, we recorded provisions for impairment of $171,000 on three properties, all of which were sold in the first nine months of 2010.

Operations from four investment properties classified as held for sale at September 30, 2011, plus properties previously sold are reported as discontinued operations. Their respective results of operations have been reclassified as income from discontinued operations on our consolidated statements of income. We do not depreciate properties that are classified as held for sale.
 

No debt was assumed by buyers of our investment properties, or repaid as a result of our investment property sales, and we do not allocate interest expense to discontinued operations related to real estate held for investment. We allocate interest expense related to borrowings specifically attributable to Crest. The interest expense amounts allocated to Crest are included in income from discontinued operations.

The following is a summary of income from discontinued operations on our consolidated statements of income (dollars in thousands):
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
Income from discontinued operations
 
2011
   
2010
   
2011
   
2010
 
Gain on sales of investment properties
  $ 3,094     $ 1,919     $ 4,319     $ 4,284  
Rental revenue
    83       519       439       2,209  
Other revenue
    7       7       35       25  
Depreciation and amortization
    (26 )     (260 )     (264 )     (892 )
Property expenses
    (111 )     (230 )     (365 )     (896 )
Provisions for impairment
    (158 )     (84 )     (368 )     (171 )
Crest’s income from discontinued operations
    222       268       664       717  
Income from discontinued operations
  $ 3,111     $ 2,139     $ 4,460     $ 5,276  
                                 
Per common share, basic and diluted
  $ 0.02     $ 0.02     $ 0.04     $ 0.05  
 
The per share amounts for income from discontinued operations above and the income from continuing operations and net income reported on the consolidated statements of income have each been calculated independently.

11.     Distributions Paid and Payable

A.  Common Stock
 
We pay monthly distributions to our common stockholders.  The following is a summary of the monthly distributions paid per common share for the first nine months of 2011 and 2010:
 
Month
 
2011
   
2010
 
January
  $ 0.1442500     $ 0.1430000  
February
    0.1442500       0.1430000  
March
    0.1442500       0.1430000  
April
    0.1445625       0.1433125  
May
    0.1445625       0.1433125  
June
    0.1445625       0.1433125  
July
    0.1448750       0.1436250  
August
    0.1448750       0.1436250  
September
    0.1448750       0.1436250  
Total
  $ 1.3010625     $ 1.2898125  

At September 30, 2011, a distribution of $0.1451875 per common share was payable and was paid in October 2011.

B.  Preferred Stock
 
In 2004, we issued 5.1 million shares of 7.375% Monthly Income Class D cumulative redeemable preferred stock. On May 27, 2009, the Class D preferred shares became redeemable, at our option, for $25 per share. During each of the first nine months of 2011 and 2010, we paid nine monthly dividends to holders of our Class D preferred stock totaling $1.3828131 per share, or $7.1 million, and at September 30, 2011, a monthly dividend of $0.1536459 per share was payable and was paid in October 2011.
 
 
In 2006, we issued 8.8 million shares of 6.75% Monthly Income Class E cumulative redeemable preferred stock. Beginning December 7, 2011, the Class E preferred shares are redeemable, at our option, for $25 per share. During each of the first nine months of 2011 and 2010, we paid nine monthly dividends to holders of our Class E preferred stock totaling $1.265625 per share, or $11.1 million, and at September 30, 2011, a monthly dividend of $0.140625 per share was payable and was paid in October 2011.
 
We are current in our obligations to pay dividends on our Class D and Class E preferred stock.

12.
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 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
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Weighted average shares used for the basic net income per share computation
    126,376,201       103,830,029       123,921,317       103,781,108  
Incremental shares from share-based compensation
    206,408       146,994       91,825       106,571  
Adjusted weighted average shares used for diluted net income per share computation
    126,582,609       103,977,023       124,013,142       103,887,679  
Unvested shares from share-based compensation that were anti-dilutive
    262,076       87,000       12,510       87,000  
 
13.
Supplemental Disclosures of Cash Flow Information
 
Interest paid in the first nine months of 2011 was $96.4 million and, in the first nine months of 2010, was $78.5 million.
 
Interest capitalized to properties under development in the first nine months of 2011 was $317,000 and, in the first nine months of 2010, was $5,000.
 
Income taxes paid in the first nine months of 2011 was $783,000 and, in the first nine months of 2010, was $947,000.

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

A.  Share-based compensation expense for the first nine months of 2011 was $6.1 million and, for the first nine months of 2010, was $4.8 million.

B.  See note 10 for a discussion of impairments recorded by Realty Income in discontinued operations, for the first nine months of 2011 and 2010.


C.  In the first nine months of 2010, we recorded a $799,000 receivable for the sale of an investment property as a result of an eminent domain action.  This receivable is included in other assets on our consolidated balance sheets at September 30, 2011 and December 31, 2010.

D.  As part of the acquisition of four properties during the first nine months of 2011, we assumed $67.4 million of mortgages payable to third-party lenders and recorded $957,000 of net premiums. Additionally, we assumed an $8.8 million note receivable. See note 6 for a discussion of these transactions.

E.  Accrued costs on properties under development resulted in an increase in buildings and improvements and accounts payable of $4.6 million at September 30, 2011.

F.  Accrued costs on properties under development resulted in an increase in buildings and improvements and accounts payable of $545,000 at September 30, 2010.

14.     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 39 industry and activity segments (including properties owned by Crest that are grouped together as a segment). 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, revenue is the only component of segment profit and loss we measure.

The following tables set forth certain information regarding the properties owned by us, classified according to the business of the respective tenants, as of September 30, 2011 (dollars in thousands):

 
   
September 30,
   
December 31,
 
Assets, as of:
 
2011
   
2010
 
Segment net real estate:
           
   Automotive service
  $ 104,676     $ 107,507  
   Automotive tire services
    191,071       195,883  
   Beverages
    308,512       302,159  
   Child care
    67,682       72,935  
   Convenience stores
    695,711       711,667  
   Drug stores
    155,223       143,739  
   Health and fitness
    292,734       220,653  
   Restaurants - casual dining
    476,004       487,141  
   Restaurants - quick service
    279,744       247,475  
   Sporting goods
    81,005       82,966  
   Theaters
    386,693       281,072  
   Transportation services
    96,966       4,961  
   Wholesale clubs
    155,979       -  
   26 non-reportable segments
    726,076       546,720  
Total segment net real estate
    4,018,076       3,404,878  
                 
Intangible assets:
   Automotive tire services
    544       588  
   Beverages
    3,635       -  
   Drug stores
    14,708       5,939  
   Health and fitness
    1,601       1,708  
   Restaurants - quick service
    4,180       -  
   Sporting goods
    5,439       5,786  
   Theaters
    32,338       1,579  
   Transportation services
    22,454       -  
   Other - non-reportable segments
    65,225       10,621  
Goodwill:
               
   Automotive service
    1,338       1,338  
   Child care
    5,353       5,353  
   Convenience stores
    2,074       2,074  
   Restaurants - casual dining
    2,461       2,461  
   Restaurants - quick service
    1,318       1,318  
   Other - non-reportable segments
    4,662       4,662  
Other corporate assets
    89,368       87,285  
Total assets
  $ 4,274,774     $ 3,535,590  
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
Revenue
 
2011
   
2010
   
2011
   
2010
 
Segment rental revenue:
                       
Automotive service
  $ 3,979     $ 4,018     $ 12,078     $ 11,907  
Automotive tire services
    5,507       5,476       17,486       16,476  
Beverages
    5,960       4,838       17,472       5,158  
Child care
    5,547       5,670       16,713       16,630  
Convenience stores
    19,512       14,340       58,355       42,775  
Drug stores
    4,017       3,479       11,777       10,343  
Health and fitness
    6,482       5,833       18,978       17,587  
Restaurants - casual dining
    11,611       11,337       34,692       34,169  
Restaurants - quick service
    6,767       6,370       19,961       20,055  
Sporting goods
    2,791       2,232       8,294       6,494  
Theaters
    9,779       7,563       25,715       22,690  
Transportation services
    2,298       187       5,146       562  
Wholesale clubs
    34       -       34       -  
26 non-reportable segments
    22,524       15,406       60,045       46,391  
Total rental revenue
    106,808       86,749       306,746       251,237  
Other revenue
    488       84       886       385  
Total revenue
  $ 107,296     $ 86,833     $ 307,632     $ 251,622  
 
 
15.     Common Stock Incentive Plan

In 2003, our Board of Directors adopted, and stockholders approved, the 2003 Incentive Award Plan of Realty Income Corporation, or the Stock Plan, to enable us to attract and retain the services of directors, employees and consultants, considered essential to our long-term success. The Stock Plan offers our directors, employees and consultants an opportunity to own stock in Realty Income and/or rights that will reflect our growth, development and financial success. The Stock Plan was amended and restated by our Board of Directors in February 2006 and in May 2007.

The amount of share-based compensation costs recognized in general and administrative expense on our consolidated statements of income during the third quarter of 2011 was $1.8 million, during the third quarter of 2010 was $1.3 million, during the first nine months of 2011 was $6.1 million and during the first nine months of 2010 was $4.8 million.

The following table summarizes our common stock grant activity under our Stock Plan.  Our common stock grants vest over periods ranging from immediately to 10 years.

   
For the nine
months ended
September 30, 2011
   
For the year ended
 December 31, 2010
 
   
Number of
shares
   
Weighted
average
price (1)
   
Number of
shares
   
Weighted
average
price (1)
 
Outstanding nonvested shares, beginning of year
    924,294     $ 19.69       853,234     $ 19.14  
Shares granted
    247,014       33.94       278,200       28.99  
Shares vested
    (245,094 )     25.26       (206,153 )     23.70  
Shares forfeited
    (348 )     31.06       (987 )     26.03  
Outstanding nonvested shares, end of each period
     925,866     $   22.12        924,294     $   19.69  
(1) Grant date fair value.

During the first nine months of 2011, we issued 247,014 shares of common stock under our Stock Plan. These shares vest over the following service periods: 25,158 vested immediately, 5,000 vest over a service period of one year, 70,400 vest over a service period of three years and 146,456 vest over a service period of five years.

As of September 30, 2011, the remaining unamortized share-based compensation expense totaled $20.5 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 Stock 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 amount to compensation expense related to dividends paid in 2011 or 2010.


As of September 30, 2011, there were no remaining stock options outstanding. During the first nine months of 2011, there were 2,454 stock options exercised, at an exercise price of $14.70, and there were no stock option forfeitures.  Stock options, none of which were granted after January 1, 2002, were granted with an exercise price equal to the underlying stock’s fair market value at the date of grant.

16.     Dividend Reinvestment and Stock Purchase Plan
 
In March 2011, we established a Dividend Reinvestment and Stock Purchase Plan, or The Plan, to provide our common stockholders, as well as new investors, with a convenient and economical method to purchase our common stock and/or reinvest their distributions. The Plan authorizes up to 6,000,000 common shares to be issued.  Through September 30, 2011, we issued 38,643 shares and received net proceeds of approximately $1.3 million under The Plan.

17.     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 September 30, 2011, we have contingent payments of $729,000 for tenant improvements and leasing costs. In addition, we have committed $15.0 million under construction contracts, which is expected to be paid in the next twelve months.

18.     Subsequent Events

In October 2011, we declared the following dividends, which are payable in November 2011:
 
-  
$0.1451875 per share to our common stockholders;
-  
$0.1536459 per share to our Class D preferred stockholders; and
-  
$0.140625 per share to our Class E preferred stockholders.

In October 2011, Friendly Ice Cream Corporation, or Friendly’s, one of our tenants, filed for voluntary reorganization under Chapter 11 of the U.S. Bankruptcy Code. Friendly’s leases 121 properties from us that, as of September 30, 2011, represented 3.6% of our rental revenue. Friendly’s rejected 15 of the 121 locations in October 2011.  We do not anticipate that this filing will have a material impact on our operations and financial position, or on our ability to pay and increase the amount of the monthly dividend.

Additionally, the principal balance of one note receivable issued in connection with a Crest property sale was paid in full during October 2011.  We received proceeds of approximately $2.9 million from this transaction.
Management's Discussion and Analysis of Financial Condition and Results of Operations


This quarterly report on Form 10-Q, including the documents incorporated by reference herein, 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 Securities 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; 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, 2010.

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.
 

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 properties leased to retail and other commercial enterprises. We have in-house acquisition, leasing, legal, credit research, real estate research, portfolio management, and capital markets expertise. Over the past 42 years, Realty Income and its predecessors have been acquiring and owning freestanding retail and other properties that generate rental revenue under long-term lease agreements (primarily 15 to 20 years).

In addition, we seek to increase distributions to stockholders and FFO per share through both active portfolio management and the acquisition of additional properties.
 
Generally, our portfolio management efforts seek to achieve:
 
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, our strategy is primarily to acquire properties that are:
 
Freestanding, single-tenant locations;
Leased to regional and national commercial enterprises; and
Leased under long-term, net-lease agreements.

At September 30, 2011, we owned a diversified portfolio:
 
Of 2,600 properties;
With an occupancy rate of 97.7%, or 2,541 properties leased and only 59 properties available for lease;
Leased to 134 different retail and other commercial enterprises doing business in 38 separate industries;
Located in 49 states;
With over 26.8 million square feet of leasable space; and
With an average leasable space per property of approximately 10,300 square feet.

Of the 2,600 properties in the portfolio, 2,584, or 99.4%, are single-tenant properties, and the remaining 16 are multi-tenant properties. At September 30, 2011, of the 2,584 single-tenant properties, 2,526 were leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 11.1 years.

In addition, at September 30, 2011, our wholly-owned taxable REIT subsidiary, Crest Net Lease, Inc., or Crest, had an inventory of three properties, which are classified as held for investment. In addition to the three properties, Crest also holds notes receivable of $22.0 million at September 30, 2011.  One of these notes receivable, in the amount of $2.9 million, was paid in full during October 2011.

We typically acquire properties under long-term leases with regional and national retailers and other commercial enterprises. Our acquisition and investment activities generally focus on businesses providing goods and services that satisfy basic consumer and business needs.


In general, our net-lease agreements:
 
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), additional rent calculated as a percentage of the tenants' gross sales above a specified level, or fixed increases.

Investment Philosophy
We believe that owning an actively managed, diversified portfolio of commercial 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 subject to future rent increases based on increases in the consumer price index (typically subject to ceilings), additional rent calculated as a percentage of the tenants' gross sales above a specified level, or fixed increases. 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.

Credit Strategy
We primarily provide sale-leaseback financing to less than investment grade tenants. We typically acquire and lease back properties to regional and national commercial enterprises and believe that within this market we can achieve an attractive risk-adjusted return. Since 1970, our overall weighted average occupancy rate at the end of each year has been 98.2%, and our occupancy rate at the end of each year has never been below 96%.

Acquisition Strategy
We seek to invest in industries in which several, well-organized, regional and national retailers and other commercial enterprises are capturing market share through service, quality control, economies of scale, strong consumer brands, advertising, and the selection of prime locations. We execute our acquisition strategy by acting as a source of capital to regional and national commercial enterprises by acquiring and leasing back their real estate locations. We undertake thorough research and analysis to identify what we consider to be 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 potential investments, we generally seek to acquire real estate that has the following characteristics:
 
Properties that are freestanding, commercially-zoned with a single tenant;
Properties that are important locations for regional and national commercial enterprises;
  
Properties that we deem to be profitable for the tenants and/or can generally be characterized as important to the operations of the company’s business;
Properties that are located within attractive demographic areas, relative to the business of our 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 our credit quality.
 
 
Our executives regularly review and analyze:
 
  
The performance of the various industries of our tenants; and
  
The operation, management, business planning, and financial condition of our 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;
  
Extend our average remaining lease term; or
  
Decrease tenant or industry concentration.

At September 30, 2011, we classified real estate with a carrying amount of $4.2 million as held for sale on our balance sheet. Additionally, we anticipate selling investment properties from our portfolio that have not yet been specifically identified, from which we anticipate receiving between $15 million and $35 million in proceeds during the next 12 months. 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 or be able to invest the proceeds from the sales of any properties in new properties.

Impact of Real Estate and Credit Markets
In the commercial real estate market, property prices generally continue to fluctuate. Likewise, 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 continue to monitor the commercial real estate and U.S. credit markets carefully and, if required, will make decisions to adjust our business strategy accordingly. See our discussion of "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2010.


Increases in Monthly Distributions to Common Stockholders
We continue our 42-year policy of paying distributions monthly. Monthly distributions per share increased in April 2011 by $0.0003125 to $0.1445625, in July 2011 by $0.0003125 to $0.144875 and in October 2011 by $0.0003125 to $0.1451875. The increase in October 2011 was our 56th consecutive quarterly increase and the 63rd increase in the amount of our dividend since our listing on the New York Stock Exchange, or NYSE, in 1994. In the first nine months of 2011, we paid three monthly cash distributions per share in the amount of $0.14425, three in the amount of $0.1445625 and three in the amount of $0.144875, totaling $1.3010625. In September 2011 and October 2011, we declared distributions of $0.1451875 per share, which were paid in October 2011 and are payable in November 2011, respectively.

The monthly distribution of $0.1451875 per share represents a current annualized distribution of $1.74225 per share, and an annualized distribution yield of approximately 5.4% based on the last reported sale price of our common stock on the NYSE of $32.24 on September 30, 2011. 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 the Third Quarter of 2011
During the third quarter of 2011, we invested $462.3 million in 89 new properties and properties under development, with an initial weighted average contractual lease rate of 8.1%. These 89 new properties, and properties under development, are located in 15 states, contain over 2.0 million leasable square feet, and are 100% leased with an average lease term of 9.6 years.


Acquisitions during the First Nine Months of 2011
During the first nine months of 2011, we invested $826.4 million in 125 new properties, and properties under development, with an initial weighted average contractual lease rate of 7.9%. The majority of the lease revenue from these properties will be generated from investment grade tenants. These 125 new properties, and properties under development, are located in 25 states, contain over 5.5 million leasable square feet, and are 100% leased with an average lease term of 11.3 years.

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

Included in the $826.4 million invested, during the first nine months of 2011, are the following acquisitions:

(1)  
In March, we announced the signing of definitive purchase agreements to acquire 33 single-tenant retail, distribution, office and manufacturing properties for approximately $544 million.  Between March and August, we acquired 32 of the 33 properties for $524.8 million.  We anticipate that we will acquire the one remaining property during the fourth quarter of 2011.
(2)  
In August, we acquired 60 properties operating in the restaurant - quick service industry for $41.9 million, under long-term, triple net lease agreements.
(3)  
In September, we acquired six properties operating in the wholesale clubs industry for $156.1 million, under long-term, triple net lease agreements.
(4)  
In September, we acquired nine properties operating in the health and fitness industry for $63.2 million, under long-term, triple net lease agreements.
(5)  
The remaining 18 properties acquired totaled approximately $40.4 million and were acquired at various times during 2011.

Portfolio Discussion
 
Leasing Results
At September 30, 2011, we had 59 properties available for lease out of 2,600 properties in our portfolio, which represents a 97.7% occupancy rate. Since December 31, 2010, when we reported 84 properties available for lease and a 96.6% occupancy rate, we:
 
  
Leased 25 properties;
  
Sold 18 properties available for lease; and
  
Have 18 new properties available for lease.

During the first nine months of 2011, 69 properties with expiring leases were leased to either existing or new tenants.  The rent on these leases was $7.3 million, as compared to the previous rent charged on these same properties of $8.0 million.  At September 30, 2011, our average annualized rental revenue per square foot was approximately $16.95.

Investments in Existing Properties
In the third quarter of 2011, we capitalized costs of $1.1 million on existing properties in our portfolio, consisting of $595,000 for re-leasing costs and $528,000 for building and tenant improvements.

In the first nine months of 2011, we capitalized costs of $3.0 million on existing properties in our portfolio, consisting of $1.3 million for re-leasing costs and $1.7 million for building and tenant improvements.


As part of our re-leasing costs, we 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 are related 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, credit worthiness, and the willingness of tenants to pay higher rents over the terms of the leases.

Re-opening of Unsecured Bonds due 2035
In June 2011, we re-opened our 5.875% senior unsecured bonds due 2035, or the 2035 Bonds, and issued $150.0 million in aggregate principal amount of additional 2035 Bonds. The public offering price for the additional 2035 Bonds was 94.578% of the principal amount for an effective yield of 6.318%. Those 2035 Bonds constituted an additional issuance of, and a single series with, the $100 million in aggregate principal amount of 2035 Bonds that we issued in March 2005. The net proceeds of approximately $140.1 million were used to fund property acquisitions.

Issuance of Common Stock
In September 2011, we issued 6,300,000 shares of common stock at a price of $34.00 per share. After underwriting discounts and other offering costs of $10.6 million, the net proceeds of $203.6 million were used to repay borrowings under our acquisition credit facility, which were used to fund recent acquisitions.

In March 2011, we issued 8,625,000 shares of common stock at a price of $34.81 per share. After underwriting discounts and offering costs of $14.6 million, the net proceeds of $285.6 million were used to fund property acquisitions.

Dividend Reinvestment and Stock Purchase Plan
In March 2011, we established a Dividend Reinvestment and Stock Purchase Plan, or The Plan, to provide our common shareholders, as well as new investors, with a convenient and economical method to purchase our common stock and/or reinvest their distributions. The Plan authorizes up to 6,000,000 common shares to be issued. Through September 30, 2011, we issued 38,643 shares and received net proceeds of approximately $1.3 million under The Plan.

Net Income Available to Common Stockholders
Net income available to common stockholders was $34.7 million in the third quarter of 2011, versus $25.6 million in the third quarter of 2010, an increase of $9.1 million. On a diluted per common share basis, net income was $0.27 in the third quarter of 2011, compared to $0.25 in the third quarter of 2010.

Net income available to common stockholders was $97.8 million in the first nine months of 2011, versus $74.7 million in the first nine months of 2010, an increase of $23.1 million. On a diluted per common share basis, net income was $0.79 in the first nine months of 2011, compared to $0.72 in the first nine months of 2010.

The calculation to determine net income available to common stockholders includes gains from the sale of properties and excess land. 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 from the sale of properties and excess land during the third quarter of 2011 was $3.1 million, as compared to $1.9 million during the third quarter of 2010. The gain from the sale of properties and excess land during the first nine months of 2011 was $4.5 million, as compared to $4.3 million during the first nine months of 2010.


Funds from Operations Available to Common Stockholders (FFO)
In the third quarter of 2011, our FFO increased by $15.6 million, or 32.6%, to $63.4 million, versus $47.8 million in the third quarter of 2010. On a diluted per common share basis, FFO was $0.50 in the third quarter of 2011, compared to $0.46 in the third quarter of 2010, an increase of $0.04, or 8.7%.

In the first nine months of 2011, our FFO increased by $39.7 million, or 28.1%, to $180.9 million, versus $141.2 million in the first nine months of 2010. On a diluted per common share basis, FFO was $1.46 in the first nine months of 2011, compared to $1.36 in the first nine months of 2010, an increase of $0.10, or 7.4%.

See our discussion of FFO (which is not a financial measure under U.S. generally accepted accounting principles, or 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.

Adjusted Funds from Operations Available to Common Stockholders (AFFO)
In the third quarter of 2011, our AFFO increased by $15.6 million, or 32.1%, to $64.2 million, versus $48.6 million in the third quarter of 2010. On a diluted per common share basis, AFFO was $0.51 in the third quarter of 2011, compared to $0.47 in the third quarter of 2010, an increase of $0.04, or 8.5%.

In the first nine months of 2011, our AFFO increased by $40.9 million, or 28.4%, to $184.8 million, versus $143.9 million in the first nine months of 2010. On a diluted per common share basis, AFFO was $1.49 in the first nine months of 2011, compared to $1.39 in the first nine months of 2010, an increase of $0.10, or 7.2%.

See our discussion of AFFO (which is not a financial measure under U.S. 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.

 
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 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 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 $425 million credit facility and occasionally 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 September 30, 2011, our total outstanding borrowings of senior unsecured notes, mortgages payable and credit facility borrowings were $1.91 billion, or approximately 29.2% of our total market capitalization of $6.56 billion.


We define our total market capitalization at September 30, 2011 as the sum of:
 
Shares of our common stock outstanding of 133,202,323 multiplied by the last reported sales price of our common stock on the NYSE of $32.24 per share on September 30, 2011, or $4.29 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;
Outstanding mortgages payable of $68.2 million;
  
Outstanding borrowings of $96.6 million on our credit facility; and
  
Outstanding senior unsecured notes and bonds of $1.75 billion.
 
Mortgage Debt
As of September 30, 2011, we have $67.3 million of mortgages payable to third-party lenders that were assumed in 2011, in connection with our property acquisitions. We paid $138,000 in principal payments on these mortgages payable during the first nine months of 2011.  Additionally, net premiums totaling $957,000, in aggregate, were recorded upon assumption of the mortgages payable at the time of the respective property acquisitions to account for above-market interest rates. We recorded amortization of $98,000 related to these net premiums during the first nine months of 2011.

Our mortgages payable are secured by the properties on which the debt was placed and are non-recourse. We expect to pay off the mortgages payable as soon as prepayment penalties and costs make it economically feasible to do so. We intend to continue our policy of primarily identifying property acquisitions that are free from mortgage indebtedness.

$425 Million Acquisition Credit Facility
In December 2010, we entered into a $425 million revolving, unsecured credit facility that replaced our previous $355 million acquisition credit facility that was scheduled to expire in May 2011. The initial term of the credit facility expires in March 2014 and includes two, one-year extension options. Under the credit facility, our investment grade credit ratings provide for financing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 185 basis points with a facility commitment fee of 35 basis points, for all-in drawn pricing of 220 basis points 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. At September 30, 2011, we had a borrowing capacity of $328.4 million available on our credit facility and an outstanding balance of $96.6 million at an effective interest rate of 2.1%.

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 have the right to request an increase in the borrowing capacity of the credit facility, up to $200 million, to a total borrowing capacity of $625 million. Any increase in the borrowing capacity is subject to approval by the lending banks participating in our credit facility.

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 September 30, 2011, we had cash and cash equivalents totaling $5.5 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 foreseeable future. We intend, however, to use additional sources of capital to fund property acquisitions and to repay future borrowings under our credit facility.


Universal Shelf Registration
In March 2009, we filed a shelf registration statement with the SEC, which expires in March 2012. In accordance with the SEC rules, the amount of the 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 common stock, preferred stock, debt securities, or 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 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.

Credit Agency Ratings
The borrowing rates under our credit facility are based upon our credit ratings. We are currently assigned the following 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.

Based on our current ratings, the current facility interest rate is LIBOR plus 185 basis points with a facility commitment fee of 35 basis points, for all-in drawn pricing of 220 basis points over LIBOR. The credit facility provides that the interest rate can range between: (i) LIBOR plus 300 basis points if our credit facility is lower than BBB-/Baa3 and (ii) LIBOR plus 175 basis points 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 ranges from (i) 50 basis points for a rating lower than BBB-/Baa3, and (ii) 30 basis points 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.

Notes Outstanding
Our senior unsecured note obligations consist of the following as of September 30, 2011, sorted by maturity date (dollars in millions):

   5.375% notes, issued in March 2003 and due in March 2013
  $ 100  
   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  
   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  
   5.875% bonds, $100 issued in March 2005 and $150 issued in June 2011, both due in March 2035
    250  
    $ 1,750  



All of our outstanding unsecured notes and bonds have fixed interest rates. Interest on all of our senior note and bond obligations is paid semiannually. All of these notes and bonds contain various covenants, including: (i) a limitation on incurrence of any debt which would cause our debt to total adjusted assets ratio to exceed 60%; (ii) a limitation on incurrence of any secured debt which would cause our secured debt to total adjusted assets ratio to exceed 40%; (iii) a limitation on incurrence of any debt which would cause our debt service coverage ratio to be less than 1.5 times; and (iv) the maintenance at all times of total unencumbered assets not less than 150% of our outstanding unsecured debt. We have been in compliance with these covenants since each of the notes and bonds was issued.

The following is a summary of the key financial covenants for our senior unsecured notes, as defined and calculated per the terms of our notes. These calculations, which are not based on U.S. GAAP, measurements, are presented to investors to show our ability to incur additional debt under the terms of our notes only and are not measures of our liquidity or performance. The actual amounts as of September 30, 2011 are:
 
Note Covenants
Required
 
Actual
 
Limitation on incurrence of total debt
≤ 60% of adjusted assets
    39.2 %
Limitation on incurrence of secured debt
≤ 40% of adjusted assets
    1.4 %
Debt service coverage (trailing 12 months)
≥ 1.5 x
    3.6 x
Maintenance of total unencumbered assets
≥ 150% of unsecured debt
    256.9 %
 
The following table summarizes the maturity of each of our obligations as of September 30, 2011 (dollars in millions):
 
Table of Obligations
                     
Ground
   
Ground
             
                           
Leases
   
Leases
             
                           
Paid by
   
Paid by
             
Year of
 
Credit
   
Notes and
   
Mortgages
         
Realty
   
Our
             
Maturity
 
Facility(1)
   
Bonds
   
Payable(2)
   
Interest (3)
   
Income(4)
   
Tenants(5)
   
Other (6)
   
Totals
 
2011
  $ --     $ --     $ 0.2     $ 27.9     $ --     $ 1.0     $ 5.7     $ 34.8  
2012
    --       --       0.6       111.6       0.2       4.0       10.0       126.4  
2013
    --       100.0       20.9       107.4       0.2       3.9       --       232.4  
2014
    96.6       --       22.0       102.6       0.2       3.7       --       225.1  
2015
    --       150.0       23.6       99.7       0.2       3.7       --       277.2  
Thereafter
    --       1,500.0       --       516.7       0.6       52.6       --       2,069.9  
Totals
  $ 96.6     $ 1,750.0     $ 67.3     $ 965.9     $ 1.4     $ 68.9     $ 15.7     $ 2,965.8  
 
 
(1) The initial term of the credit facility expires in March 2014 and includes two, one-year extension options.
 
(2) Excludes net premiums of $957,000 recorded on the mortgages payable.
 
(3) Interest on the credit facility, notes, bonds and mortgages payable has been calculated based on outstanding balances as of September 30, 2011 through their respective maturity dates.
 
(4) Realty Income currently pays the ground lessors directly for the rent under the ground leases.
 
(5) 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.
 
(6) “Other” consists of $15.0 million of commitments under construction contracts and $729,000 of contingent payments for tenant improvements and leasing costs. The amounts allocated to 2011 and 2012 have been estimated.

Our credit facility and notes payable obligations are unsecured. Accordingly, we have not pledged any assets as collateral for these obligations. Our mortgages payable are secured by the properties on which the debt was placed and are non-recourse.

Preferred Stock Outstanding
In 2004, we issued 5.1 million shares of 7.375% Class D cumulative redeemable preferred stock. On May 27, 2009, shares of Class D preferred stock became redeemable at our option for $25 per share, plus any accrued and unpaid dividends. Dividends on shares of Class D preferred stock are paid monthly in arrears.


In 2006, we issued 8.8 million shares of 6.75% Class E cumulative redeemable preferred stock. Beginning December 7, 2011, shares of Class E preferred stock are redeemable at our option for $25 per share, plus any accrued and unpaid dividends. Dividends on shares of Class E preferred stock are paid monthly in arrears.

We are current in our obligations to pay dividends on our Class D and Class E preferred stock.

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. Additionally, we have no joint ventures or mandatorily redeemable preferred stock. As such, our financial position and results of operations are not affected by accounting regulations regarding the consolidation of off-balance sheet entities and classification of financial instruments with characteristics of both liabilities and equity.

Distribution Policy
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 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 2010, our cash distributions totaled $206.8 million, or approximately 136.5% of our REIT taxable income of $151.5 million. Our REIT taxable income reflects non-cash deductions for depreciation and amortization. Our 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 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 nine months of 2011, totaled $161.3 million, representing 89.2% of our funds from operations available to common stockholders of $180.9 million. In comparison, our 2010 cash distributions to common stockholders totaled $182.5 million, representing 94.2% of our funds from operations available to common stockholders of $193.7 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). Dividends on our Class D and Class E 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, cash flow from operations, financial condition and 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” 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, 2012). 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 taxable corporations (such as our taxable REIT subsidiary, Crest) 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).

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 26.8% of the distributions to our common stockholders, made or deemed to have been made in 2010, 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.

Matters Pertaining to a Certain Tenant
On October 5, 2011, Friendly Ice Cream Corporation, or Friendly’s, one of our tenants, filed for voluntary reorganization under Chapter 11 of the U.S. Bankruptcy Code. Friendly’s leases 121 properties from us that, as of September 30, 2011, represented 3.6% of our rental revenue. In its filing, Friendly’s rejected the leases on only 15 of our 121 properties, representing approximately $1.3 million of annualized rental revenue. Any properties returned to us are immediately available for re-lease to other tenants. We believe  that the demand in the market for these 15 properties will allow us to find suitable replacement tenants within the next 12 months. We anticipate that the majority of the properties should remain under lease, and that any stores that are vacated or where rental payments are adjusted as a result of the filing will not have a material impact on our operations and financial position, or on our ability to pay and increase the amount of the monthly dividend. However, there can be no assurance that Friendly’s will continue to pay rent for the remainder of the lease term on the remaining properties.


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, 2010.

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 years. If we use a shorter or longer estimated useful life, it could have a material impact on our results of operations. We believe that 25 years is an appropriate estimate of useful life.
 
 
When acquiring a property for investment purposes, we allocate the fair value of real estate acquired to: (1) land and (2) building and improvements, based in each case on their estimated fair values. In addition, any assumed mortgages payable are recorded at their estimated fair values.
 
For properties acquired with in-place operating leases, we 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 and below-market leases, the value of in-place leases, and tenant relationships.

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. Generally, 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, capital expenditures, property holding periods, 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 sheet. If events should occur that require us to reduce the carrying value of our real estate by recording provisions for impairment, it could have a material impact on our results of operations.

The following is a comparison of our results of operations for the three and nine months ended September 30, 2011 to the three and nine months ended September 30, 2010:

Rental Revenue
Rental revenue was $106.8 million for the third quarter of 2011, versus $86.7 million for the third quarter of 2010, an increase of $20.1 million, or 23.2%. The increase in rental revenue in the third quarter of 2011, compared to the third quarter of 2010, is primarily attributable to:
 
  
The 125 properties (5.5 million square feet) acquired by Realty Income in 2011, which generated $9.6 million of rent in the third quarter of 2011;
  
The 186 retail properties (2.3 million square feet) acquired by Realty Income in 2010, which generated $14.1 million of rent in the third quarter of 2011 compared to $5.5 million of rent in the third quarter of 2010, for an increase of $8.6 million;
Same store rents generated on 2,159 properties (17.8 million square feet) during the entire third quarters of 2011 and 2010, increased by $1.4 million, or 1.8%, to $81.1 million from $79.7 million;
  
A net increase of $304,000 relating to the aggregate of (i) rental revenue from 114 properties (1.1 million square feet) that were available for lease during part of 2011 or 2010, (ii) rental revenue related to 49 properties sold during 2011 and 2010 and (iii) lease termination settlements, which, in aggregate, totaled $1.5 million in the third quarter of 2011 compared to $1.2 million in the third quarter of 2010; and
  
A net increase in straight-line rent and other non-cash adjustments to rent of $76,000 in the third quarter of 2011 as compared to the third quarter of 2010.

Rental revenue was $306.7 million for the first nine months of 2011, versus $251.2 million for the first nine months of 2010, an increase of $55.5 million, or 22.1%.  The increase in rental revenue in the first nine months of 2011, compared to the first nine months of 2010, is primarily attributable to:
 
  
The 125 properties (5.5 million square feet) acquired by Realty Income in 2011, which generated $15.2 million of rent in the first nine months of 2011;
The 186 properties (2.3 million square feet) acquired by Realty Income in 2010, which generated $42.06 million of rent in the first nine months of 2011 compared to $6.44 million in the first nine months of 2010, for an increase of $35.6 million;

 
Same store rents generated on 2,159 properties (17.8 million square feet) during the entire first nine months of 2011 and 2010 increased by $3.7 million, or 1.5%, to $243.0 million from $239.3 million;
  
A net increase of $1.2 million relating to the aggregate of (i) rental revenue from 114 properties (1.1 million square feet) that were available for lease during part of 2011 or 2010, (ii) rental revenue related to 49 properties sold during 2011 and 2010, and (iii) lease termination settlements, which in aggregate, totaled $5.6 million in the first nine months of 2011 compared to $4.4 million in the first nine months of 2010; and
  
A net decrease in straight-line rent and other non-cash adjustments to rent of $202,000 in the first nine months of 2011 as compared to the first nine months of 2010.

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 available for lease at any time, (ii) were under development, (iii) we have made an additional investment, (iv) were involved in eminent domain and rent was reduced and (v) were re-leased with rent-free periods.  Each of the exclusions from the same store pool is separately addressed within the applicable sentences above explaining the changes in rental revenue for the period.  To enhance comparability of the results for the quarterly and year-to-date information, we have elected to use the same pool of properties for both the three and nine month analyses.

Of the 2,600 properties in the portfolio at September 30, 2011, 2,584, or 99.4%, are single-tenant properties and the remaining 16 are multi-tenant properties. Of the 2,584 single-tenant properties, 2,526, or 97.8%, were net leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 11.1 years at September 30, 2011. Of our 2,526 leased single-tenant properties, 2,342, or 92.7%, were under leases that provide for increases in rents through:
 
Primarily base rent increases tied to a consumer price index (typically subject to ceilings);
Overage 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 $241,000 in the third quarter of 2011 and $207,000 in the third quarter of 2010. Percentage rent was $921,000 in the first nine months of 2011 and $918,000 in the first nine months of 2010. Percentage rent in the third quarter and first nine months of 2011 was less than 1% of rental revenue and we anticipate percentage rent to continue to be less than 1% of rental revenue for the remainder of 2011.

Our portfolio of real estate, leased primarily to regional and national commercial enterprises under net leases, continues to perform well and provides dependable lease revenue supporting the payment of monthly dividends to our stockholders. At September 30, 2011, our portfolio of 2,600 properties was 97.7% leased with 59 properties available for lease as compared to 84 at December 31, 2010 and at September 30, 2010. 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.

Depreciation and Amortization
For the third quarter of 2011, depreciation and amortization was $31.9 million as compared to $23.9 million for the third quarter of 2010. For the first nine months of 2011, depreciation and amortization was $87.5 million as compared to $70.1 million for the first nine months of 2010. The increase in depreciation and amortization in 2011 was primarily due to the acquisition of properties in 2011 and 2010, which was partially offset by property sales in those same years. As discussed in the section entitled "Funds from Operations Available to Common Stockholders," 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
Interest expense was $28.6 million for the third quarter of 2011, as compared to $25.1 million for the third quarter of 2010. Interest expense was $79.3 million for the first nine months of 2011, as compared to $68.1 million for the first nine months of 2010.  The increase in interest expense from 2010 to 2011 was primarily due to an increase in borrowings attributable to the issuance of our $250 million of 5.75% senior unsecured notes in June 2010, the $150 million re-opening of our 5.875% senior unsecured bonds due 2035 in June 2011 and higher credit facility commitment fees and origination costs as a result of our $425 million acquisition credit facility, which was entered into in December 2010.
 
 The following is a summary of the components of our interest expense (dollars in thousands):
   
Three months ended
   
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September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Interest on our credit facility, notes, bonds and mortgages
  $ 27,627     $ 24,260     $ 76,531     $ 65,677  
Interest included in discontinued operations
    (198 )     (137 )     (597 )     (400 )
Credit facility commitment fees
    377       248       1,131       743  
Amortization of credit facility origination costs, deferred financing costs and net mortgage premiums
     888        766        2,570        2,091  
Interest capitalized
    (144 )     (2 )     (317 )     (5 )
Interest expense
  $ 28,550     $ 25,135     $ 79,318     $ 68,106  

   
Three months ended
   
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September 30,
   
September 30,
 
Credit facility, mortgages and notes outstanding
 
2011
   
2010
   
2011
   
2010
 
Average outstanding balances (dollars in thousands)
  $ 1,797,848     $ 1,621,010     $ 1,675,706     $ 1,456,643  
Average interest rates
    5.9 %     6.0 %     6.0 %     6.0 %

At September 30, 2011, the weighted average interest rate on our:
 
  
Notes and bonds payable of $1.75 billion was 6.03%;
  
Mortgages payable of $68.2 million was 5.4%;
  
Credit facility outstanding borrowings of $96.6 million was 2.09%; and
  
Combined outstanding notes, bonds, mortgages and credit facility borrowings of $1.9 billion was 5.8%.

EBITDA and Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization)
EBITDA and Adjusted EBITDA are non-GAAP financial measures. Our EBITDA and Adjusted EBITDA computation may not be comparable to EBITDA and Adjusted EBITDA reported by other companies that interpret the definitions of EBITDA and Adjusted EBITDA differently than we do. Management believes EBITDA and Adjusted EBITDA to be meaningful measures of a REIT's performance because it is widely followed by industry analysts, lenders and investors and is used by management as one measure of performance. In addition, management utilizes Adjusted EBITDA because our $425 million credit facility uses a similar metric to measure our compliance with certain covenants. EBITDA and Adjusted EBITDA should be considered along with, but not an alternative to, net income, cash flow and FFO, as measures of our operating performance.


The following is a reconciliation of net income, our most directly comparable GAAP measure, to Adjusted EBITDA (dollars in thousands):
 
   
Three months ended
   
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September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Net income
  $ 40,780     $ 31,654     $ 116,027     $ 92,907  
Interest expense
    28,550       25,135       79,318       68,106  
Interest expense included in discontinued operations
    198       137       597       400  
Income taxes
    367       335       1,102       890  
Income tax benefit included in discontinued operations
    (90 )     (88 )     (268 )     (288 )
Depreciation and amortization
    31,869       23,941       87,542       70,145  
Depreciation and amortization in discontinued operations
    26       260       264       892  
EBITDA
    101,700       81,374       284,582       233,052  
Provisions for impairment
    169       84       378       171  
Amortization of net premiums on mortgages payable
    (98 )     --       (98 )     --  
Gain on property sales
    (55 )     --       (210 )     --  
Gain on property sales in discontinued operations
    (3,094 )     (1,919 )     (4,319 )     (4,284 )
Adjusted EBITDA
  $ 98,622     $ 79,539     $ 280,333     $ 228,939  

Interest Coverage Ratio
Interest coverage ratio is calculated as: Adjusted EBITDA divided by interest expense, including interest recorded as discontinued operations. We consider interest coverage ratio to be an appropriate supplemental measure of a company's ability to meet its interest expense obligations. Our calculation of interest coverage ratio may be different from the calculation used by other companies and, therefore, comparability may be limited. This information should not be considered as an alternative to any GAAP liquidity measures.
 
   
Three months ended
   
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September 30,
   
September 30,
 
Dollars in thousands
 
2011
   
2010
   
2011
   
2010
 
Adjusted EBITDA
  $ 98,622     $ 79,539     $ 280,333     $ 228,939  
Divided by interest expense(1)
  $ 28,748     $ 25,272     $ 79,915     $ 68,506  
Interest coverage ratio
    3.4       3.1       3.5       3.3  
 
 (1)   Includes interest expense recorded to discontinued operations.

Fixed Charge Coverage Ratio
Fixed charge coverage ratio is calculated in exactly the same manner as interest coverage ratio, except that preferred stock dividends are also added to the denominator. 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 calculation of the fixed charge coverage ratio may be different from the calculation used by other companies and, therefore, comparability may be limited. This information should not be considered as an alternative to any GAAP liquidity measures.

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
Dollars in thousands
 
2011
   
2010
   
2011
   
2010
 
Adjusted EBITDA
  $ 98,622     $ 79,539     $ 280,333     $ 228,939  
Divided by interest expense plus preferred stock dividends(1)
  $ 34,811     $ 31,335     $ 98,105     $ 86,696  
Fixed charge coverage ratio
    2.8       2.5       2.9       2.6  
 
(1) Includes interest expense recorded to discontinued operations.


General and Administrative Expenses
General and administrative expenses increased by $978,000 to $7.1 million in the third quarter of 2011, as compared to $6.2 million in the third quarter of 2010. Included in general and administrative expenses are acquisition transaction costs of $233,000 for the third quarter of 2011, as compared to $102,000 for the third quarter of 2010. General and administrative expenses increased, during the three and nine months ended September 30, 2011, primarily due to increases in employee costs and higher acquisition transaction costs. In the third quarter of 2011, general and administrative expenses, as a percentage of total revenue, were 6.7%, as compared to 7.1% in the third quarter of 2010.
 
 
General and administrative expenses increased by $3.5 million to $23.0 million in the first nine months of 2011, as compared to $19.5 million in the first nine months of 2010. Included in general and administrative expenses are acquisition transaction costs of $1.1 million for the first nine months of 2011, as compared to $191,000 for the first nine months of 2010. As a percentage of total revenue, general and administrative expenses were 7.5%, in the first nine months of 2011, as compared to 7.8% in the first nine months of 2010. In October 2011, we had 80 employees, as compared to 76 employees in October 2010.

Property Expenses
Property expenses are broken down into costs associated with unleased properties, non-net leased multi-tenant properties and general portfolio expenses. Expenses related to unleased properties and multi-tenant 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 September 30, 2011, 59 properties were available for lease, as compared to 84 at December 31, 2010 and at September 30, 2010.

Property expenses were $1.7 million in the third quarters of 2011 and 2010. Property expenses were $5.1 million in the first nine months of 2011, and $5.3 million in the first nine months of 2010. The decrease in property expenses, in the first nine months of 2011, is primarily attributable to a decrease in bad debt expense and a decrease in maintenance and utilities, partially offset by an increase in insurance costs associated with properties available for lease. Property expenses, for the three and nine months ended September 30, 2011, include $10,000 related to a provision for impairment on one property.

Income Taxes
Income taxes were $367,000 in the third quarter of 2011, as compared to $335,000 in the third quarter of 2010. Income taxes were $1.1 million in the first nine months of 2011, as compared to $890,000 in the first nine months of 2010. These amounts are for city and state income taxes paid by Realty Income.

Discontinued Operations
Operations from four investment properties classified as held for sale at September 30, 2011, plus properties previously sold, have been classified as discontinued operations. The following is a summary of income from discontinued operations on our consolidated statements of income (dollars in thousands):

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
Income from discontinued operations
 
2011
   
2010
   
2011
   
2010
 
Gain on sales of investment properties
  $ 3,094     $ 1,919     $ 4,319     $ 4,284  
Rental revenue
    83       519       439       2,209  
Other revenue
    7       7       35       25  
Depreciation and amortization
    (26 )     (260 )     (264 )     (892 )
Property expenses
    (111 )     (230 )     (365 )     (896 )
Provisions for impairment
    (158 )     (84 )     (368 )     (171 )
Crest’s income from discontinued operations
    222       268       664       717  
Income from discontinued operations
  $ 3,111     $ 2,139     $ 4,460     $ 5,276