Realty Income, The Monthly Dividend Companyฎ, is a publicly traded real estate company with the primary business objective of generating dependable monthly cash dividends from a consistent and predictable level of cash flow from operations. Our monthly dividends are supported by the cash flow from our portfolio of properties leased to commercial tenants. We have in-house acquisition, leasing, legal, credit research, real estate research, portfolio management and capital markets expertise. Over the past 45 years, Realty Incomeand its predecessors have been acquiring and owning freestanding commercial properties that generate rental revenue under long-term lease agreements. Realty Incomewas founded in 1969, and in 1994 was listed upon the NYSE. We elected to be taxed as a real estate investment trust, or REIT, requiring us to distribute dividends to our stockholders aggregating at least 90% of our taxable income (excluding net capital gains). We seek to increase distributions to stockholders and funds from operations, or FFO, per share through both active portfolio management and the acquisition of additional properties.
Of 3,896 properties;
With an occupancy rate of 98.2%, or 3,826 properties leased and 70 properties available for lease;
Leased to 205 different commercial tenants doing business in 47 separate industries;
Located in 49 states and
Puerto Rico; With over 62.6 million square feet of leasable space; and
With an average leasable space per property of approximately 16,100 square feet, including approximately 10,600 square feet per retail property.
Of the 3,896 properties in the portfolio, 3,876, or 99.5%, are single-tenant properties, and the remaining are multi-tenant properties. At
December 31, 2013, of the 3,876 single-tenant properties, 3,807 were leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 10.8 years. LIQUIDITY AND CAPITAL RESOURCES Capital Philosophy Historically, we have met our long-term capital needs by issuing common stock, preferred stock and long-term unsecured notes and bonds. Over the long term, we believe that common stock should be the majority of our capital structure. However, we may issue additional preferred stock or debt securities. We may issue common stock when we believe that our share price is at a level that allows for the proceeds of any offering to be accretively invested into additional properties. In addition, we may issue common stock to permanently finance properties that were financed by our credit facility or debt securities. However, we cannot assure you that we will have access to the capital markets at times and at terms that are acceptable to us. Our primary cash obligations, for the current year and subsequent years, are included in the "Table of Obligations," which is presented later in this section. We expect to fund our operating expenses and other short-term liquidity requirements, including property acquisitions and development costs, payment of principal and interest on our outstanding indebtedness, property improvements, re-leasing costs and cash distributions to common and preferred stockholders, primarily through cash provided by operating activities, borrowing on our $1.5 billioncredit facility and periodically through public securities offerings. -34-
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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
December 31, 2013, our total outstanding borrowings of senior unsecured notes and bonds, term loan, mortgages payable and credit facility borrowings were $4.18 billion, or approximately 33.2% of our total market capitalization of $12.59 billion. We define our total market capitalization at December 31, 2013as the sum of: Shares of our common stock outstanding of 207,485,073, plus total common units of 851,568, multiplied by the closing sales price of our common stock on the NYSEof $37.33per share on December 31, 2013, or $7.78 billion;
Aggregate liquidation value (par value of
Aggregate liquidation value (par value of
Outstanding borrowings of
Outstanding mortgages payable of
Outstanding borrowings of
Outstanding senior unsecured notes and bonds of
December 31, 2013, we had $754.5 millionof mortgages payable, all of which were assumed in connection with our property acquisitions. Included in this amount is $514.4 millionof mortgages payable assumed in connection with the ARCT acquisition. Additionally, at December 31, 2013, we had net premiums totaling $28.9 millionon these mortgages, of which $16.2 millionis in connection with the ARCT acquisition. We expect to pay off the mortgages payable as soon as prepayment penalties have declined to a level that will make it economically feasible to do so. We intend to continue to primarily identify property acquisitions that are free from mortgage indebtedness. During 2013, we made $41.4 millionof principal payments, which includes $11.7 millionto pay off one mortgage in August 2013and $23.1 millionto pay off three mortgages in December 2013.
January 2013, in conjunction with our acquisition of ARCT, we entered into a $70 millionsenior unsecured term loan maturing in January 2018. Borrowing under the term loan bears interest at LIBOR, plus 1.20%. In conjunction with this term loan, we also acquired an interest rate swap which essentially fixes our per annum interest rate on the term loan at 2.15%.
October 2013, we increased our unsecured acquisition credit facility from $1.0 billionto $1.5 billion. The initial term of the credit facility expires in May 2016and includes, at our election, a one-year extension option. Under this credit facility, our current investment grade credit ratings provide for financing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 1.075% with a facility commitment fee of 0.175%, for all-in drawn pricing of 1.25% over LIBOR. The borrowing rate is not subject to an interest rate floor or ceiling. We also have other interest rate options available to us under this credit facility. Our credit facility is unsecured and, accordingly, we have not pledged any assets as collateral for this obligation. At December 31, 2013, we had a borrowing capacity of $1.372 billionavailable on our credit facility (subject to customary conditions to borrowing) and an outstanding balance of $128.0 million. The interest rate on borrowings outstanding under our credit facility, at December 31, 2013, was 1.2% per annum. We must comply with various financial and other covenants in our credit facility. At December 31, 2013, we remain in compliance with these covenants. We expect to use our credit facility to acquire additional properties and for other corporate purposes. Any additional borrowings will increase our exposure to interest rate risk. We regularly review our credit facility and may seek to extend or replace our credit facility, to the extent we deem appropriate.
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We generally use our credit facility for the short-term financing of new property acquisitions. Thereafter, when capital is available on acceptable terms, we generally seek to refinance those borrowings with the net proceeds of long-term or permanent financing, which may include the issuance of common stock, preferred stock or debt securities. We cannot assure you, however, that we will be able to obtain any such refinancing, or that market conditions prevailing at the time of the refinancing will enable us to issue equity or debt securities upon acceptable terms.
total net proceeds of approximately
$741.4 millionfrom this offering was used to repay all outstanding borrowings under our acquisition credit facility, and the remaining proceeds were used for other general corporate purposes and working capital, including additional property acquisitions.
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
December 31, 2013, we had cash and cash equivalents totaling $10.3 million. We believe that our cash and cash equivalents on hand, cash provided from operating activities, and borrowing capacity is sufficient to meet our liquidity needs for the next twelve months. We intend, however, to use permanent or long-term capital to fund property acquisitions and to repay future borrowings under our credit facility. Acquisitions During 2013 During 2013, Realty Incomeinvested $1.51 billionin 459 new properties and properties under development or expansion (in addition to our acquisition of ARCT, which is discussed in more detail below), with an initial weighted average contractual lease rate of 7.1%. The 459 new properties and properties under development or expansion, are located in 40 states, will contain approximately 9.0 million leasable square feet, and are 100% leased with a weighted average lease term of 14.0 years. The tenants occupying the new properties operate in 23 industries and the property types consist of 83.8% retail, 9.2% office, 4.9% industrial and distribution, and 2.1% manufacturing, based on rental revenue. These investments are in addition to the $3.2 billionacquisition of 515 properties of American Realty Capital Trust, Inc., or ARCT, which were added to our real estate portfolio during the first quarter of 2013. Our combined total investment in real estate assets during 2013 was $4.67 billionin 974 new properties and properties under development or expansion. During 2013, none of our real estate investments caused any one tenant to be 10% or more of our total assets at December 31, 2013. Additionally, in September 2013, we purchased a property for $45.4 millionin San Diego, California, which will serve as our new corporate headquarters. We plan on relocating to this facility during the second half of 2014. In conjunction with our acquisition of ARCT, each outstanding share of ARCT common stock was converted into the right to receive a combination of: (i) $0.35in cash and (ii) 0.2874 shares of our common stock, resulting in the issuance of a total of approximately 45.6 million shares of our common stock to ARCT shareholders, valued at a per share amount of $44.04, which was the closing sale price of our common stock on January 22, 2013. In connection with the closing of this acquisition, we terminated and repaid the amounts then outstanding of approximately $552.9 millionunder ARCT's revolving credit facility and term loan. In connection with our acquisition of ARCT, we assumed approximately $516.3 millionof mortgages payable. We incurred merger costs of $13.0 millionand $7.9 million, respectively, in 2013 and 2012. The total merger costs were approximately $21 million. -36-
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The acquisition of ARCT provided benefits to
Realty Income, including accretion to net earnings, growth in the size of our real estate portfolio, diversification of industries and property type, and increase in the percentage of investment grade tenants. The 515 properties added to our real estate portfolio as a result of the ARCT acquisition, are located in 44 states and Puerto Rico, contain over 16.0 million leasable square feet and are 100% leased with a weighted average lease term of 12.2 years. The 69 tenants, occupying the 515 properties acquired, operate in 28 industries and the property types consist of 54.0% retail, 32.6% industrial and distribution, and 13.4% office, based on rental revenue. The estimated initial weighted average contractual lease rate for a property is generally computed as estimated contractual net operating income, which, in the case of a net leased property, is equal to the aggregate base rent under the lease for the first full year of each lease, divided by the total cost of the property. Since it is possible that a tenant could default on the payment of contractual rent, we cannot provide assurance that the actual return on the funds invested will remain at the percentages listed above. In the case of a property under development or expansion, the estimated initial weighted average contractual lease rate is computed as follows: estimated net operating income (which is calculated by multiplying the capitalization rate determined by the lease by our projected total investment in the property, including land, construction and capitalized interest costs) for the first full year of each lease, divided by such projected total investment in the property. Of the $4.67 billionwe invested during 2013, excluding the new corporate headquarters, $39.6 millionwas invested in 21 properties under development or expansion, with an estimated initial weighted average contractual lease rate of 8.5%. We may continue to pursue development or expansion opportunities under similar arrangements in the future.
John P. Case Appointed Chief Executive Officer (CEO)
September 2013, we announced that our Board of Directors appointed John P. Caseas CEO of the company. Mr. Case, who had previously served as President and Chief Investment Officer, succeeded Tom A. Lewis, who retired as our CEO. Mr. Lewishad been our CEO since 1997. Mr. Caseis only the third CEO in Realty Income's45-year history. Portfolio Discussion Leasing Results
Leased 27 properties; Sold 19 properties available for lease; and Have 32 new properties available for lease. During 2013, 136 properties with expiring leases were leased to either existing or new tenants. The annual rent on these leases was
$16.1 million, as compared to the previous rent on these same properties of $16.0 million. At December 31, 2013, our average annualized rental revenue per square foot was approximately $13.21per square foot on the 3,807 leased properties in our portfolio. At December 31, 2013, we classified 12 properties with a carrying amount of $12.0 millionas held for sale on our balance sheet.
In 2013, we capitalized costs of
$8.5 millionon existing properties in our portfolio, consisting of $1.3 millionfor re-leasing costs and $7.2 millionfor building and tenant improvements. In 2012, we capitalized costs of $6.6 millionon existing properties in our portfolio, consisting of $1.62 millionfor re-leasing costs and $4.93 millionfor building 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. -37-
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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.
Impact of Real Estate and Credit Markets
In the commercial real estate market, property prices generally continue to fluctuate. Likewise, during certain periods, the U.S. credit markets have experienced significant price volatility, dislocations and liquidity disruptions, which may impact our access to and cost of capital. We continually monitor the commercial real estate and U.S. credit markets carefully and, if required, make decisions to adjust our business strategy accordingly. See our discussion of "Risk Factors" in this annual report.
Increases in Monthly Dividends to Common Stockholders
We have continued our 45-year policy of paying monthly dividends. In addition, we increased the dividend five times during 2013.
Month Dividend Increase 2013 Dividend increases Paid per share per share 1st increase Jan 2013
$ 0.1517500 $ 0.00031252nd increase Feb 2013 0.1809167 0.0291667 3rd increase Apr 2013 0.1812292 0.0003125 4th increase Jul 2013 0.1815417 0.0003125 5th increase Oct 2013 0.1818542 0.0003125 The dividends paid per share during 2013 as compared to 2012 increased 21.2%, which is the largest annual increase in the company's history. The 2013 dividends paid per share totaled $2.1474587as compared to $1.7716250in 2012, an increase of $0.3758337. In December 2013, we declared an increased dividend of $0.1821667per share, which was paid in January 2014. The increase in January 2014was our 65th consecutive quarterly increase and the 74th increase in the amount of the dividend since our listing on the NYSEin 1994. In January 2014and February 2014, we declared dividends of $0.1821667per share, which will be paid in February 2014and March 2014, respectively. The monthly dividend of $0.1821667per share represents a current annualized dividend of $2.186per share, and an annualized dividend yield of approximately 5.9% based on the last reported sale price of our common stock on the NYSEof $37.33on December 31, 2013. Although we expect to continue our policy of paying monthly dividends, we cannot guarantee that we will maintain our current level of dividends, that we will continue our pattern of increasing dividends per share, or what our actual dividend yield will be in any future period. -38- --------------------------------------------------------------------------------
Table of Contents Universal Shelf Registration In
February 2013, we filed a shelf registration statement with the SEC, which is effective for a term of three years and will expire in February 2016. This replaces our prior shelf registration statement. In accordance with SECrules, the amount of securities to be issued pursuant to this shelf registration statement was not specified when it was filed and there is no specific dollar limit. The securities covered by this registration statement include (1) common stock, (2) preferred stock, (3) debt securities, (4) depositary shares representing fractional interests in shares of preferred stock, (5) warrants to purchase debt securities, common stock, preferred stock or depositary shares, and (6) any combination of these securities. We may periodically offer one or more of these securities in amounts, prices and on terms to be announced when and if 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.
Accelerated Stock Vesting
The Compensation Committee of our Board of Directors approved, effective
July 1, 2013, the accelerated vesting of each restricted stock award that had originally been granted with ten-year vesting to five years. On July 1, 2013, 212,827 restricted shares vested as a result of this acceleration, resulting in additional compensation expense of $3.7 millionduring 2013.
Issuance of Common Stock
October 2013, we issued 9,775,000 shares of common stock at a price of $40.63per share, including 1,275,000 shares purchased by the underwriters upon the exercise of their option to purchase additional shares. After underwriting discounts and other estimated offering costs of $18.7 million, the net proceeds of approximately $378.5 millionwere used to repay a portion of the borrowings under our acquisition credit facility, which were used to fund property acquisitions. In March 2013, we issued 17,250,000 shares of common stock at a price of $45.90per share. After underwriting discounts and other offering costs of $36.7 million, the net proceeds of $755.1 millionwere used to redeem our 5.375% notes in March 2013and repay borrowings under our acquisition credit facility, which were used to fund property acquisitions, including our acquisition of ARCT. In connection with our January 2013acquisition of ARCT, we issued a total of 45,573,144 shares of our common stock to ARCT shareholders and redeemed 208,709 shares of our common stock that were previously held by ARCT.
Dividend Reinvestment and Stock Purchase Plan
March 2011, we established a Dividend Reinvestment and Stock Purchase Plan, or the DRSPP, to provide our common stockholders, as well as new investors, with a convenient and economical method of purchasing our common stock and reinvesting their distributions. The DRSPP also allows our current stockholders to buy additional shares of common stock by reinvesting all or a portion of their distributions. The DRSPP authorizes up to 6,000,000 common shares to be issued. During 2013, we issued 1,449,139 shares and raised approximately $55.6 millionunder the DRSPP. Noncontrolling Interests As consideration for two separate acquisitions during 2013, partnership units of Tau Operating Partnership, L.P.and Realty Income, L.P.were issued to third parties. These units (discussed in the following paragraphs below) do not have voting rights, are entitled to monthly distributions equal to the amount paid to our common stockholders, and are redeemable in cash or our common stock, at our option and at a conversion ratio of one to one, subject to certain exceptions. As the general partner for each of these partnerships, we have operating and financial control over these entities, consolidate them in our financial statements, and record the partnership units held by third parties as noncontrolling interests.
Issuance of Common and Preferred Partnership Units
In connection with our acquisition of ARCT in
January 2013, we issued 317,022 common partnership units and 6,750 preferred partnership units. These common units are entitled to monthly distributions equivalent to the per common share amounts paid to the common stockholders of Realty Income. The preferred units have a par value of $1,000, and are entitled to monthly payments at a rate of 2% per annum, or $135,000per year. -39- --------------------------------------------------------------------------------
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June 2013, we issued 534,546 common partnership units of Realty Income, L.P.These common units are entitled to monthly distributions equivalent to the per common share amount paid to the common stockholders of Realty Income.
Credit Agency Ratings
The borrowing interest rates under our credit facility are based upon our ratings assigned by credit rating agencies. We are currently assigned the following investment grade corporate credit ratings on our senior unsecured notes and bonds: Fitch Ratings has assigned a rating of BBB+ with a "stable" outlook, Moody's Investors Service has assigned a rating of Baa1 with a "stable" outlook, and Standard & Poor's
Ratings Grouphas assigned a rating of BBB+ with a "stable" outlook. Based on our current ratings, the credit facility interest rate is LIBORplus 1.075% with a facility commitment fee of 0.175%, for all-in drawn pricing of 1.25% over LIBOR. The credit facility provides that the interest rate can range between: (i) LIBORplus 1.85% if our credit facility is lower than BBB-/Baa3 and (ii) LIBORplus 1.00% if our credit rating is A-/A3 or higher. In addition, our credit facility provides for a facility commitment fee based on our credit ratings, which range from: (i) 0.45% for a rating lower than BBB-/Baa3, and (ii) 0.15% for a credit rating of A-/A3 or higher.
We also issue senior debt securities and our credit ratings can impact the interest rates charged in those transactions. In addition, 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.
Our senior unsecured note and bond obligations consist of the following as of
5.5% notes, issued in
November 2003and due in November 2015$
5.95% notes, issued in
September 2006and due in September 2016
5.375% notes, issued in
September 2005and due in September 2017
2.0% notes, issued in
October 2012and due in January 2018
6.75% notes, issued in
September 2007and due in August 2019
5.75% notes, issued in
June 2010and due in January 2021
3.25% notes, issued in
October 2012and due in October 2022
4.65% notes, issued in
July 2013and due in August 2023
Total principal amount
Unamortized original issuance discounts (15 )
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All of our outstanding 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. At
December 31, 2013, we remain in compliance with these covenants. 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 December 31, 2013are: Note Covenants Required Actual
Limitation on incurrence of total debt < 60% of adjusted assets 41.5% Limitation on incurrence of secured debt < 40% of adjusted assets
Debt service coverage (trailing 12 months)(1) > 1.5 x
3.6 x Maintenance of total unencumbered assets > 150% of unsecured debt 251.9%
(1) This covenant is calculated on a pro forma basis for the preceding four-quarter period on the assumption that: (i) the incurrence of any Debt (as defined in the covenants) incurred by us since the first day of such four-quarter period and the application of the proceeds therefrom (including to refinance other Debt since the first day of such four-quarter period), (ii) the repayment or retirement of any of our Debt since the first day of such four-quarter period, and (iii) any acquisition or disposition by us of any asset or group since the first day of such four-quarters had in each case occurred on
January 1, 2013, and subject to certain additional adjustments. Such pro forma ratio has been prepared on the basis required by that debt service covenant, reflects various estimates and assumptions and is subject to other uncertainties, and therefore does not purport to reflect what our actual debt service coverage ratio would have been had transactions referred to in clauses (i), (ii) and (iii) of the preceding sentence occurred as of January 1, 2013, nor does it purport to reflect our debt service coverage ratio for any future period. The following is our calculation of debt service coverage at December 31, 2013(in thousands, for trailing twelve months):
Net income attributable to the Company
174,007 Plus: provision for taxes 1,808 Plus: depreciation and amortization 308,394 Plus: provisions for impairment 3,028 Plus: pro forma adjustments 59,625
Less: gain on sales of investment properties (64,743 ) Income available for debt service, as defined
$ 201,848Debt service coverage ratio 3.6
Fixed Charge Coverage Ratio
Fixed charge coverage ratio is calculated in exactly the same manner as the debt service coverage ratio, except that preferred stock dividends are also added to the denominator. Similar to debt service coverage ratio, we consider fixed charge coverage ratio to be an appropriate supplemental measure of a company's ability to make its interest and preferred stock dividend payments. Our calculations of both debt service and fixed charge coverage ratios may be different from the calculations used by other companies and, therefore, comparability may be limited. The presentation of debt service and fixed charge coverage ratios should not be considered as alternatives to any U.S. generally accepted accounting principles, or GAAP, operating performance measures. Below is our calculation of fixed charges at
December 31, 2013(in thousands, for trailing twelve months): Income available for debt service, as defined $ 727,683Pro forma debt service charge plus preferred stock dividends $ 243,778Fixed charge coverage ratio 3.0 -41-
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The following table summarizes the maturity of each of our obligations as of
Ground Ground Leases Leases Notes Paid by Paid by Year of Credit and Term Mortgages
Maturity Facility (1) Bonds (2) Loan Payable (3) Interest (4) Income (5) Tenants (6) Other (7) Totals
2014 $ - $ - $ -
2015 - 150.0 - 125.5 193.6 1.0 12.7 - 482.8 2016 128.0 275.0 - 248.5 167.9 1.0 12.7 - 833.1 2017 - 175.0 - 133.0 145.2 1.0 12.8 - 467.0 2018 - 350.0 70.0 15.0 127.0 1.0 12.8 - 575.8 Thereafter - 2,250.0 - 182.6 539.2 9.4 144.5 - 3,125.7 Totals
$ 128.0 $ 3,200.0 $ 70.0 $ 754.5 $ 1,372.4 $ 14.4 $ 208.1 $ 25.4 $ 5,772.8
(1) The initial term of the credit facility expires in
(2) Excludes non-cash original issuance discounts recorded on the notes payable. The unamortized balance of the original issuance discounts at
(3) Excludes non-cash net premiums recorded on the mortgages payable. The unamortized balance of these net premiums at
(4) Interest on the term loan, notes, bonds, mortgages payable, and credit facility has been calculated based on outstanding balances as of
(6) Our tenants, who are generally sub-tenants under ground leases, are responsible for paying the rent under these ground leases. In the event a tenant fails to pay the ground lease rent, we are primarily responsible.
(7) "Other" consists of
Our credit facility and notes payable obligations are unsecured. Accordingly, we have not pledged any assets as collateral for these obligations.
Preferred Stock and Preferred Units Outstanding
In 2006, we issued 8.8 million shares of Class E preferred stock. Beginning
February 2012, we issued 14.95 million shares of our Class F preferred stock at $25.00per share. In April 2012, we issued an additional 1.4 million shares of Class F preferred stock at $25.2863per share. Beginning February 15, 2017, shares of our Class F preferred stock are redeemable at our option for $25.00per share, plus any accrued and unpaid dividends. Dividends on the shares of our Class F preferred stock are paid monthly in arrears.
We are current on our obligations to pay dividends on our Class E and Class F preferred stock.
As part of our acquisition of ARCT in
January 2013, we issued 6,750 partnership units. Payments on these preferred units are made monthly in arrears at rate of 2% per annum, or $135,000per year, and are included in interest expense.
No Unconsolidated Investments
We have no unconsolidated investments, nor do we engage in trading activities involving energy or commodity contracts.
Table of Contents RESULTS OF OPERATIONS
Critical Accounting Policies
Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or 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 order to prepare our consolidated financial statements according to the rules and guidelines set forth by GAAP, many subjective judgments must be made with regard to critical accounting policies. One of these judgments is our estimate for useful lives in determining depreciation expense for our properties. Depreciation on a majority of our buildings and improvements is computed using the straight-line method over an estimated useful life of 25 to 35 years for buildings and 4 to 15 years for improvements. 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 to 35 years is an appropriate estimate of useful life. Management must make significant assumptions in determining the fair value of assets acquired and liabilities assumed. When acquiring a property for investment purposes, we typically allocate the fair value of real estate acquired to: (1) land, (2) building and improvements, and (3) identified intangible assets and liabilities, based in each case on their estimated fair values. Intangible assets and liabilities consist of above-market or below-market lease value of in-place leases, the value of in-place leases, and tenant relationships, as applicable. In an acquisition of multiple properties, we must also allocate the purchase price among the properties. The allocation of the purchase price is based on our assessment of estimated fair value and is often based upon the expected future cash flows of the property and various characteristics of the markets where the property is located. In addition, any assumed mortgages receivable or payable and any assumed or issued noncontrolling interests are recorded at their estimated fair values. The estimated fair values of our mortgages payable have been calculated by discounting the future cash flows using applicable interest rates that have been adjusted for factors, such as industry type, tenant investment grade, maturity date, and comparable borrowings for similar assets. The initial allocation of the purchase price is based on management's preliminary assessment, which may differ when final information becomes available. Subsequent adjustments made to the initial purchase price allocation are made within the allocation period, which typically does not exceed one year. The use of different assumptions in the allocation of the purchase price of the acquired properties and liabilities assumed could affect the timing of recognition of the related revenue and expenses. Another significant judgment must be made as to if, and when, impairment losses should be taken on our properties when events or a change in circumstances indicate that the carrying amount of the asset may not be recoverable. A provision is made for impairment if estimated future operating cash flows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value of the property. Key inputs that we estimate in this analysis include projected rental rates, estimated holding periods, capital expenditures, and property sales capitalization rates. If a property is held for sale, it is carried at the lower of carrying cost or estimated fair value, less estimated cost to sell. The carrying value of our real estate is the largest component of our consolidated balance sheet. Our strategy of primarily holding properties, long-term, directly decreases the likelihood of their carrying values not being recoverable, thus requiring the recognition of an impairment. However, if our strategy, or one or more of the above assumptions were to change in the future, an impairment may need to be recognized. If events should occur that require us to reduce the carrying value of our real estate by recording provisions for impairment, they could have a material impact on our results of operations. -43- --------------------------------------------------------------------------------
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The following is a comparison of our results of operations for the years ended
Rental revenue was
$747.6 millionfor 2013 versus $466.5 millionfor 2012, an increase of $281.1 million, or 60.3%. Rental revenue was $401.0 millionin 2011. The increase in rental revenue in 2013 compared to 2012 is primarily attributable to:
The 958 properties (25.0 million square feet) acquired by
The 423 properties (10.5 million square feet) acquired by
Realty Incomein 2012, which generated $81.1 millionof rent in 2013 compared to $22.7 millionin 2012, an increase of $58.4 million; Same store rents generated on 2,338 properties (25.3 million square feet) during the entire years of 2013 and 2012, increased by $6.2 million, or 1.4%, to $435.2 millionfrom $429.0 million; A net increase of $1.8 millionrelating to the aggregate of (i) rental revenue from properties (132 properties comprising 1.1 million square feet) that were available for lease during part of 2013 or 2012, (ii) rental revenue for six properties under development, (iii) rental revenue for 29 properties re-leased primarily with rent-free periods, and (iv) lease termination settlements which, in aggregate, totaled $12.56 millionin 2013 compared to $10.74 millionin 2012; and
A net increase in straight-line rent and other non-cash adjustments to rent of
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 in, (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. Of the 3,896 properties in the portfolio at
December 31, 2013, 3,876, or 99.5%, are single-tenant properties and the remaining twenty are multi-tenant properties. Of the 3,876 single-tenant properties, 3,807, or 98.2%, were net leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 10.8 years at December 31, 2013. Of our 3,807 leased single-tenant properties, 3,419 or 89.8% were under leases that provide for increases in rents through:
Primarily base rent increases tied to a consumer price index (typically subject to ceilings);
Percentage rent based on a percentage of the tenants' gross sales; Fixed increases; or A combination of two or more of the above rent provisions. Percentage rent, which is included in rental revenue, was
$2.8 millionin 2013, $1.9 millionin 2012 and $1.3 millionin 2011 (excluding percentage rent reclassified to discontinued operations of $115,000in 2013, $163,000in 2012 and $70,000in 2011). Percentage rent in 2013 was less than 1% of rental revenue and we anticipate percentage rent to be less than 1% of rental revenue in 2014. Our portfolio of real estate, leased primarily to regional and national commercial tenants under net leases, continues to perform well and provides dependable lease revenue supporting the payment of monthly dividends to our stockholders. At December 31, 2013, our portfolio of 3,896 properties was 98.2% leased with 70 properties available for lease as compared to 97.2% portfolio occupancy, or 84 properties available for lease at December 31, 2012. 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.
Contractually obligated reimbursements from tenants for recoverable real estate taxes and operating expenses were
$24.9 millionin 2013, compared to $14.6 millionin 2012 and $9.8 millionin 2011. The increase in tenant reimbursements from 2012 to 2013 is primarily due to our 2012 and 2013 acquisitions, including our acquisition of ARCT. Our tenant reimbursements match our reimbursable property expenses for any given period. -44- --------------------------------------------------------------------------------
Table of Contents Other Revenue Other revenue, which comprises property-related revenue not included in rental revenue or tenant reimbursements, was
$5.9 millionin 2013, compared to $1.7 millionin 2012 and $1.6 millionin 2011.
Depreciation and Amortization
Depreciation and amortization was
$306.6 millionin 2013, compared to $147.3 millionin 2012 and $116.5 millionin 2011. The increases in depreciation and amortization in 2013 and 2012 were primarily due to the acquisition of properties in 2013 and 2012, including the 515 properties acquired as part of our acquisition of ARCT, which was partially offset by property sales in those same years. As discussed in the sections entitled "Funds from Operations Available to Common Stockholders (FFO) and Normalized Funds from Operations Available to Common Stockholders (Normalized FFO)" and "Adjusted Funds from Operations Available to Common Stockholders (AFFO)," depreciation and amortization is a non-cash item that is added back to net income available to common stockholders for our calculation of FFO, normalized FFO and AFFO.
Interest expense was
$180.9 millionin 2013, compared to $122.5 millionin 2012 and $108.3 millionin 2011. The increase in interest expense from 2012 to 2013 was primarily due to an increase in borrowings attributable to the issuance in October 2012of our 2.00% senior unsecured notes due January 2018, the issuance in October 2012of our 3.25% senior unsecured notes due October 2022, the January 2013issuance of our $70 millionsenior unsecured term loan, the July 2013issuance of our 4.65% senior unsecured notes due August 2023, and an increase in mortgages payable and higher credit facility borrowings, which were partially offset by lower average interest rates and the repayment of our 5.375% senior unsecured notes in March 2013. The following is a summary of the components of our interest expense (dollars in thousands): 2013 2012 2011 Interest on our credit facility, term loan, notes and mortgages $ 182,974 $ 117,401 $ 104,452Interest included in discontinued operations (526 ) (601 ) (785 ) Credit facility commitment fees 1,930 1,684
Amortization of credit facility origination costs and deferred financing costs 7,434 5,165
(Gain) loss on interest rate swap (878 ) 56 (4 ) Amortization of net mortgage premiums (9,481 ) (665 ) (189 ) Interest capitalized (537 ) (498 ) (438 ) Interest expense
$ 180,916 $ 122,542 $ 108,301Credit facility, term loan, mortgages and notes 2013 2012
Average outstanding balances (dollars in thousands)
$ 3,892,089 $ 2,144,690 $ 1,754,935Average interest rates 4.67 % 5.47 % 5.95 %
Notes and bonds payable of
Mortgages payable of
Credit facility outstanding borrowings of
$128.0 millionwas 1.2%; Term loan outstanding borrowings of $70.0 millionwas 1.4%; and
Combined outstanding notes, bonds, mortgages and credit facility borrowings of
General and Administrative Expenses
General and administrative expenses increased by
$18.8 millionto $56.8 millionin 2013, as compared to $38.0 millionin 2012. General and administrative expenses were $31.0 millionin 2011. Included in general and administrative expenses are acquisition transaction costs (excluding ARCT merger-related costs) of $2.1 millionfor 2013, $2.4 millionfor 2012 and $1.5 millionfor 2011. Even though general and administrative expenses increased during 2013, general and administrative expenses as a percentage of total revenue decreased. The increase in expense was primarily due to increases in employee costs, including the accelerated vesting of restricted shares in July 2013which resulted in additional compensation expense of $3.7 million, and higher -45- --------------------------------------------------------------------------------
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costs as a result of our integration of ARCT. In
Dollars in thousands 2013 2012
General and administrative expenses
$ 56,827 $ 37,998 $ 30,954Total revenue, including discontinued operations(1) 759,889 483,671
General and administrative expenses as a percentage of total revenue 7.5 % 7.9 % 7.3 %
(1) Excludes all tenant reimbursements revenue, as well as gain on sales and Crest Net revenue included in discontinued operations.
Property Expenses (including reimbursable)
Property expenses consist of costs associated with unleased properties, non-net leased properties and general portfolio expenses, as well as contractually obligated reimbursements from tenants for recoverable real estate taxes and operating expenses. Expenses related to unleased properties and non-net leased properties include, but are not limited to, property taxes, maintenance, insurance, utilities, property inspections, bad debt expense and legal fees. General portfolio costs include, but are not limited to, insurance, legal, property inspections, and title search fees. At
December 31, 2013, 70 properties were available for lease, as compared to 84 at December 31, 2012and 87 at December 31, 2011. Property expenses were $38.8 million(including $24.9 millionreimbursable) in 2013, $21.3 million(including $14.6 millionreimbursable) in 2012 and $15.5 million(including $9.8 millionreimbursable) in 2011. The increase in property expenses in 2013 is primarily attributable to increased portfolio size, higher maintenance and utilities, insurance costs, property taxes, and ground rent expenses as a result of our acquisition of ARCT, along with higher contractually obligated reimbursements primarily due to our 2012 and 2013 acquisitions.
Income taxes were
$2.7 millionin 2013, as compared to $1.4 millionin 2012 and $1.5 millionin 2011. These amounts are for city and state income and franchise taxes paid by Realty Incomeand its subsidiaries.
Merger-related costs include, but are not limited to, advisor fees, legal fees, accounting fees, printing fees and transfer taxes related to our acquisition of ARCT. Merger-related costs were
$13.0 millionin 2013 and $7.9 millionin 2012. On a diluted per common share basis, these expenses represented $0.07for 2013 and $0.06for 2012. Discontinued Operations Operations from ten Realty Incomeinvestment properties, two Crest properties classified as held for sale at December 31, 2013, and 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): Income from discontinued operations 2013 2012
Gain on sales of investment properties
$ 64,743 $ 9,873 $ 5,193Rental revenue 6,040 15,161 19,546 Tenant reimbursements 146 379 370 Other revenue 418 282 94 Depreciation and amortization (1,761 ) (3,916 ) (5,568 ) Property expenses (including reimbursable) (916 ) (2,529 ) (2,518 ) Provisions for impairment (2,738 ) (1,500 ) (395 ) Crest's income from discontinued operations 1,171 683 688 Income from discontinued operations $ 67,103 $ 18,433$
Per common share, basic and diluted
$ 0.35 $ 0.14 $ 0.14-46-
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Crest's Assets and Property Sales
December 31, 2013, Crest had an inventory of three properties, one of which was classified as held for investment. In addition to the three properties, Crest also held notes receivable of $18.7 millionat December 31, 2013and $18.9 millionat December 31, 2012. During 2013, Crest did not acquire any properties. However, Crest sold one property in 2013 for $597,000, and recorded an impairment of $308,000upon the sale of this property. During 2012, Crest acquired one property for $890,000, but did not sell any properties. During 2011, Crest did not buy or sell any properties.
Gain on Sales of Investment Properties by
During 2013, we sold 75 investment properties for
$134.2 million, which resulted in a gain of $64.7 million. The results of operations for these properties have been reclassified as discontinued operations. During 2012, we sold 44 investment properties for $50.6 million, which resulted in a gain of $9.9 million. The results of operations for these properties have been reclassified as discontinued operations. During 2011, we sold 26 investment properties for $22.0 million, which resulted in a gain of $5.2 million. The results of operations for these properties have been reclassified as discontinued operations. Additionally, we sold excess real estate from five properties for $2.1 million, which resulted in a gain of $540,000. This gain is included in other revenue on our consolidated statement of income for 2011, because this excess real estate was associated with properties that continue to be owned as part of our core operations.
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
December 31, 2013, we classified real estate with a carrying amount of $12.0 millionas held for sale on our balance sheet. In 2014, we intend to continue our active disposition efforts to further enhance our real estate portfolio and anticipate approximately $50 millionin property sales for all of 2014. We intend to invest these proceeds into new property acquisitions, if there are attractive opportunities available. However, we cannot guarantee that we will sell properties during the next 12 months at our estimated values or be able to invest the property sale proceeds in new properties.
Provisions for Impairment on Real Estate Acquired for Resale by Crest
During 2013, Crest recorded a provision for impairment of
During 2012 and 2011, Crest did not record any provisions for impairment.
Provisions for Impairment on
Realty Incomerecorded total provisions for impairment of $3.0 million. Provisions for impairment of $2.7 millionare included in income from discontinued operations on seven sold properties and one property classified as held for sale. Additionally, during 2013, Realty Incomerecorded provisions for impairment of $290,000on one property held for investment in the automotive service industry. This provision for impairment is included in income from continuing operations. In 2012, Realty Incomerecorded total provisions for impairment of $5.1 million. Provisions for impairment of $1.5 millionare included in income from discontinued operations on six properties. Additionally, during 2012, Realty Incomerecorded provisions for impairment of $3.6 millionon four properties held for investment at December 31, 2012. These provisions for impairment are included in income from continuing operations. -47- --------------------------------------------------------------------------------
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Realty Incomerecorded total provisions for impairment of $405,000on four properties. These provisions for impairment are included in income from discontinued operations, except for $10,000which is included in income from continuing operations. Preferred Stock Dividends
Preferred stock dividends totaled
Excess of Redemption Value over Carrying Value of Preferred Shares Redeemed
When we redeemed our Class D preferred stock in
March 2012, we incurred a charge of $3.7 millionfor the excess of redemption value over the carrying value. This charge, representing the Class D preferred stock original issuance cost that was paid in 2004, was recorded as a reduction to net income available to common stockholders when the shares were redeemed during the first quarter of 2012. On a diluted per common share basis, this charge was $0.03.
Net Income Available to Common Stockholders
Net income available to common stockholders was
$203.6 millionin 2013, an increase of $89.1 millionas compared to $114.5 millionin 2012. Net income available to common stockholders in 2011 was $132.8 million. Net income available to common stockholders in 2013 includes $13.0 millionof merger-related costs for the acquisition of ARCT, which represents $0.07on a diluted per common share basis, and $3.7 millionfor accelerated vesting of restricted shares that occurred in July 2013from ten-year vesting to five years, which represents $0.02on a diluted per common share basis. Net income available to common stockholders in 2012 includes $7.9 millionof merger-related costs related to the acquisition of ARCT, which represents $0.06on a diluted per common share basis, and a $3.7 millioncharge for the excess of redemption value over carrying value of the Class D preferred shares, which represents $0.03on a diluted per common share basis.
The calculation to determine net income available to common stockholders includes gains from the sale of properties. The amount of gains varies from period to period based on the timing of property sales and can significantly impact net income available to common stockholders.
Gains from the sale of investment properties during 2013 were
$64.7 million, as compared to gains from the sale of investment properties of $9.9 millionduring 2012 and a $5.7 milliongain from the sale of properties during 2011.
FUNDS FROM OPERATIONS AVAILABLE TO COMMON STOCKHOLDERS (FFO) AND NORMALIZED
FUNDS FROM OPERATIONS AVAILABLE TO COMMON STOCKHOLDERS (Normalized FFO)
FFO for 2013 increased by
$188.1 million, or 72.1%, to $449.0 million, as compared to $260.9 millionin 2012 and $249.4 millionin 2011. FFO for 2013 includes $13.0 millionfor merger-related costs related to our acquisition of ARCT, which represents $0.07on a diluted per common share basis, and $3.7 millionfor accelerated vesting of restricted shares that occurred in July 2013from ten-year vesting to five years, which represents $0.02on a diluted per common share basis. FFO for 2012 includes $7.9 millionof merger-related costs, which represents $0.06on a diluted per common share basis, and a $3.7 millioncharge associated with the Class D preferred stock redemption in March 2012, which represents $0.03on a diluted per common share basis. We define normalized FFO as FFO excluding the merger-related costs for our 2013 acquisition of ARCT. Normalized FFO for 2013 increased by $193.2 million, or 71.9%, to $462.0 million, as compared to $268.8 millionin 2012 and $249.4 millionin 2011. -48-
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The following is a reconciliation of net income available to common stockholders (which we believe is the most comparable GAAP measure) to FFO and normalized FFO. Also presented is information regarding distributions paid to common stockholders and the weighted average number of common shares used for the basic and diluted computation per share (dollars in thousands, except per share amounts): 2013 2012 2011 Net income available to common stockholders
$ 203,634 $ 114,538 $ 132,779Depreciation and amortization: Continuing operations 306,577 147,323
Discontinued operations 1,818 3,984
Depreciation allocated to noncontrolling interest (1,009 ) - - Depreciation of furniture, fixtures and equipment (288 ) (249 ) (238 ) Provisions for impairment on investment properties 3,028 5,139 405 Gain on sale of investment properties: continuing operations - - (540 ) discontinued operations (64,743 ) (9,873 ) (5,193 ) FFO available to common stockholders 449,017 260,862
Merger-related costs 13,013 7,899 - Normalized FFO available to common stockholders
$ 462,030 $ 268,761 $ 249,392FFO per common share: Basic $ 2.34 $ 1.96 $ 1.98Diluted $ 2.34 $ 1.96 $ 1.98Normalized FFO per common share, Basic $ 2.41 $ 2.02 $ 1.98Diluted $ 2.41 $ 2.02 $ 1.98Distributions paid to common stockholders $ 409,222 $ 236,348 $ 219,297Normalized FFO in excess of distributions paid to common stockholders $ 52,808 $ 32,413 $ 30,095Weighted average number of common shares used for computation per share: Basic 191,754,857 132,817,472 126,142,696 Diluted 191,781,622 132,884,933 126,189,399 We define FFO, a non-GAAP measure, consistent with the National Association of Real Estate Investment Trust'sdefinition, as net income available to common stockholders, plus depreciation and amortization of real estate assets, plus impairments of depreciable real estate assets, reduced by gains on the sale of investment properties and extraordinary items. We define normalized FFO, a non-GAAP measure, as FFO excluding the merger-related costs for our 2013 acquisition of ARCT. We consider FFO and normalized FFO to be appropriate supplemental measures of a REIT's operating performance as they are based on a net income analysis of property portfolio performance that adds back items such as depreciation and impairments for FFO, and adds back merger-related costs, for normalized FFO. The historical accounting convention used for real estate assets requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time. Since real estate values historically rise and fall with market conditions, presentations of operating results for a REIT, using historical accounting for depreciation, could be less informative. The use of FFO is recommended by the REIT industry as a supplemental performance measure. In addition, FFO is used as a measure of our compliance with the financial covenants of our credit facility. -49- --------------------------------------------------------------------------------
Table of Contents ADJUSTED FUNDS FROM OPERATIONS AVAILABLE TO COMMON STOCKHOLDERS (AFFO) AFFO for 2013 increased by
$188.9 million, or 68.9%, to $463.1 million, as compared to $274.2 millionin 2012 and $253.4 millionin 2011. We consider AFFO to be an appropriate supplemental measure of our performance. Most companies in our industry use a similar measurement, but they may use the term "CAD" (for Cash Available for Distribution), "FAD" (for Funds Available for Distribution), or other terms. The following is a reconciliation of net income available to common stockholders (which we believe is the most comparable GAAP measure) to FFO, normalized FFO and AFFO. Also presented is information regarding distributions paid to common stockholders and the weighted average number of common shares used for the basic and diluted computation per share (dollars in thousands, except per share amounts): 2013 2012 2011 Net income available to common stockholders $ 203,634 $ 114,538 $ 132,779Cumulative adjustments to calculate FFO(1) 245,383 146,324
FFO available to common stockholders 449,017 260,862
Merger-related costs 13,013 7,899 - Normalized FFO available to common stockholders 462,030 268,761
Provisions for impairment on Crest properties 308 - - Amortization of share-based compensation 20,785 10,001
Amortization of deferred financing costs(2) 4,436 2,786
Excess of redemption value over carrying value of Class D preferred share redemption - 3,696 - Amortization of net mortgage premiums (9,481 ) (665 ) (189 ) (Gain) loss on interest rate swaps (878 ) 56 (4 ) Capitalized leasing costs and commissions (1,280 ) (1,619 ) (1,722 ) Capitalized building improvements (7,227 ) (4,935 ) (2,450 ) Straight-line rent (13,742 ) (5,674 ) (2,681 ) Amortization of above and below-market leases 8,188 1,776
Total AFFO available to common stockholders
$ 463,139 $ 274,183
AFFO per common share, basic and diluted: Basic
$ 2.42 $ 2.06 $ 2.01Diluted $ 2.41 $ 2.06 $ 2.01Distributions paid to common stockholders $ 409,222 $ 236,348 $ 219,297AFFO in excess of distributions paid to common stockholders $ 53,917 $ 37,835
Weighted average number of common shares used for computation per share: Basic 191,754,857 132,817,472 126,142,696 Diluted 191,781,622 132,884,933 126,189,399
(1) See reconciling items for FFO presented under "Funds from Operations Available to Common Stockholders (FFO) and Normalized Funds from Operations Available to Common Stockholders (Normalized FFO)."
(2) Includes the amortization of costs incurred and capitalized when our notes were issued in
March 2003, November 2003, March 2005, September 2005, September 2006, September 2007, June 2010, June 2011, October 2012, and July 2013. Additionally, this includes the amortization of deferred financing costs incurred and capitalized in connection with our assumption of the mortgages payable and the issuance of our term loan. The deferred financing costs are being amortized over the lives of the respective mortgages and term loan. No costs associated with our credit facility agreements or annual fees paid to credit rating agencies have been included. -50- --------------------------------------------------------------------------------
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We believe the non-GAAP financial measure AFFO provides useful information to investors because it is a widely accepted industry measure of the operating performance of real estate companies that is used by industry analysts and investors who look at and compare those companies. In particular, AFFO provides an additional measure by which to compare the operating performance of different REITs without having to account for differing depreciation assumptions and other unique revenue and expense items which are not pertinent to the measurement of the particular company's on-going operating performance. Therefore, we believe that AFFO is an appropriate supplemental performance metric, and that the most appropriate GAAP performance metric to which AFFO should be reconciled is net income available to common stockholders. Presentation of the information regarding FFO, normalized FFO and AFFO is intended to assist the reader in comparing the operating performance of different REITs, although it should be noted that not all REITs calculate FFO, normalized FFO and AFFO in the same way, so comparisons with other REITs may not be meaningful. Furthermore, FFO, normalized FFO and AFFO are not necessarily indicative of cash flow available to fund cash needs and should not be considered as alternatives to net income as an indication of our performance. FFO, normalized FFO and AFFO should not be considered as alternatives to reviewing our cash flows from operating, investing, and financing activities. In addition, FFO, normalized FFO and AFFO should not be considered as measures of liquidity, of our ability to make cash distributions, or of our ability to pay interest payments. IMPACT OF INFLATION Tenant leases generally provide for limited increases in rent as a result of increases in the tenants' sales volumes, increases in the consumer price index (typically subject to ceilings), and/or fixed increases. We expect that inflation will cause these lease provisions to result in rent increases over time. During times when inflation is greater than increases in rent, as provided for in the leases, rent increases may not keep up with the rate of inflation. Of our 3,896 properties in our portfolio, approximately 97.7% or 3,807 are leased to tenants under net leases where the tenant is responsible for property expenses. Net leases tend to reduce our exposure to rising property expenses due to inflation. Inflation and increased costs may have an adverse impact on our tenants if increases in their operating expenses exceed increases in revenue. IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS