Realty Income Corporation — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Amounts are in U.S. dollars; financial statement figures are unaudited.
Business context
Realty Income is an equity REIT focused on freestanding commercial properties, primarily under long-term net leases. At quarter-end it owned 2,523 properties in 49 states, with 97.3% occupancy, 131 tenants across 37 industries, and an approximately 11.1-year weighted-average remaining lease term on leased single-tenant properties.
Financial performance and liquidity
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $102.6 million | $82.4 million | $200.4 million | $164.9 million |
| Income from continuing operations | $38.0 million | $29.0 million | $73.8 million | $58.1 million |
| Net income available to common stockholders | $33.2 million | $25.0 million | $63.1 million | $49.1 million |
| Diluted net income per common share | $0.26 | $0.24 | $0.51 | $0.47 |
| FFO per diluted share | $0.48 | $0.45 | $0.96 | $0.90 |
| AFFO per diluted share | $0.49 | $0.46 | $0.98 | $0.92 |
- Rental revenue rose 24.6% in Q2 and 21.5% year to date. Same-store rents increased 1.8% in Q2 and 1.4% for the six-month period.
- Net cash provided by operating activities was $137.0 million for the first six months, up from $110.5 million. Investing activities used $304.7 million, mainly for property acquisitions; financing activities provided $305.8 million. Cash ended at $155.7 million versus $17.6 million at year-end 2010.
- At June 30, total liabilities were $1.90 billion, including $1.75 billion of notes and bonds and $59.6 million of mortgages. Total borrowings were about 28.2% of stated market capitalization. The $425 million revolving credit facility was undrawn, leaving $425 million available.
- Debt covenant measures were within stated limits: total debt to adjusted assets 39.2% (maximum 60%); secured debt 1.3% (maximum 40%); debt service coverage 3.5x (minimum 1.5x); and unencumbered assets to unsecured debt 263.9% (minimum 150%). Management reported compliance with covenants.
- Interest coverage was 3.6x and fixed-charge coverage was 2.9x for both Q2 and the first six months. Weighted-average interest rates were 6.03% on notes and 4.92% on mortgages; the facility borrowing rate was approximately 2.04% if drawn.
- Common distributions paid in the first six months were $106.1 million, or 90.3% of FFO. The monthly common distribution increased to $0.144875 in July, equivalent to an annualized $1.7385 per share; the company said it could not guarantee future distribution levels or increases.
Material changes and notable items
- During the first six months, the company invested $364.2 million in 36 properties and properties under development, at an initial weighted-average contractual lease rate of 7.6%; the acquired and developing properties were reported as 100% leased, with a 15.5-year average lease term.
- The company had announced agreements to acquire 33 properties for approximately $544 million. By June 30, it had invested $336.2 million in 22 of them and expected the remainder to close within the next two months. Funding included a March common-stock offering that netted $285.6 million and a June bond reopening that netted $140.1 million.
- Common shares issued and outstanding increased to 126.9 million from 118.1 million at December 31, 2010, reflecting the 8.625 million-share offering. Weighted-average diluted shares also increased materially, to 126.2 million in Q2 from 103.8 million a year earlier.
- Q2 FFO increased 30.1% in total but 6.7% per diluted share; six-month FFO increased 25.8% in total and 6.7% per diluted share. AFFO per diluted share grew 6.5% in both comparisons. These are non-GAAP measures and are not substitutes for cash flow or liquidity measures.
- Interest expense increased to $25.6 million in Q2 from $21.6 million and to $50.8 million for the six months from $43.0 million, mainly reflecting higher borrowing and credit-facility costs. Gains on property sales were lower year over year and contributed less to reported earnings.
- Ten investment properties were classified as held for sale, with a $6.4 million carrying value. Management anticipated $10–$35 million in proceeds from other, not-yet-identified property sales over the next 12 months, subject to market conditions and available reinvestment opportunities.
Outlook, risks and contingencies
- Management said cash on hand, operating cash flow and available borrowing capacity should meet liquidity needs for the foreseeable future; much of the quarter-end cash was intended for the announced acquisitions. No specific earnings or FFO guidance was provided.
- Management cited uncertainty in commercial real estate and credit markets and identified risks including tenant defaults, interest-rate changes, capital-market access and cost, competition, real estate impairments, environmental matters, property illiquidity, natural disasters, REIT qualification and legal proceedings.
- Rent increases may not keep pace with inflation; inflation or higher operating costs could also pressure tenants. Most leases are net leases, which generally place property operating expenses on tenants.
- There were $12.4 million of construction-contract commitments and $924,000 of contingent tenant-improvement and leasing-cost payments. The company reported routine legal matters that it did not expect to have a material adverse effect.
- Six-month property impairments were $210,000, versus $87,000 in the prior-year period. No goodwill impairment was recorded. Management reported effective disclosure controls and no material change in internal control over financial reporting; it reported no material change in risk factors from the 2010 Form 10-K.
Most important facts for investors to verify
- Whether the remaining 11 properties in the announced $544 million acquisition close on schedule, and the resulting acquisition yields and financing needs.
- Whether per-share FFO and AFFO growth continues after the substantial increase in common shares outstanding.
- Whether operating cash flow supports distributions and planned acquisitions, given distributions paid and heavy acquisition spending.
- Tenant and industry concentration, occupancy trends, and renewal economics; the 44 leases renewed or re-leased in the first six months carried $4.2 million of rent versus $4.5 million previously.
- Debt maturities, the variable-rate mortgage exposure, covenant headroom, and access to debt and equity capital markets.
- Management’s assumptions for planned property sales and reinvestment, and the potential effect of impairments or tenant defaults on results.